FINAL STATEMENT:

Publication Date: 17 January 2019

Review of the Second Class Safeguard Caps

2019

Price caps for Second Class standard letters, large letters and parcels up to 2kg

[] Redacted for publication

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Contents

Section

1. Overview 2

2. Introduction and summary of the regulatory framework 6

3. Market analysis 19

4. Assessing affordability 44

5. Commercial flexibility 64

6. Our decision 75

Annex

A1. Statutory notification: Modified Designated USP Conditions 2 and 3 83

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1. Overview 1.1 Postal services are essential to the UK economy and are a very important communication

method for many people. Most consumers value postal services. Older people and those

without internet access are particularly reliant on the postal service to communicate.1

1.2 Ofcom has legal duties to secure an efficient and financially sustainable universal postal

service. The universal service currently requires Royal Mail, as its provider, to deliver and

collect letters six days a week, and parcels five days a week, at an affordable and uniform

price throughout the UK.

1.3 The current regulation for postal services has been in place since March 2012. At that

time, the universal service network was making a loss and Royal Mail’s future provision of

the universal service was under threat. To help sustain the universal service Ofcom granted

Royal Mail greater commercial and operational flexibility to meet these challenges.

1.4 At the same time, we imposed safeguard caps on Royal Mail’s retail prices for the

following “Second Class products”:

• a Second Class standard letter safeguard cap; and

• a ‘basket’ cap, comprising Second Class large letters and small and medium parcels

weighing up to 2kg2.

1.5 The caps are designed to ensure that a basic, affordable, universal postal service is

available to consumers and small businesses; that users of postal services, especially

vulnerable consumers, are protected from ongoing price increases; that Royal Mail can

earn a reasonable commercial rate of return on the safeguarded products, and that the

effect of the safeguard caps on Royal Mail’s pricing freedom is minimised so as to avoid a

material effect on wider financeability.

1.6 The current safeguard caps expire on 31 March 2019. This document sets out our

decisions for regulating the Second Class products for the period 1 April 2019 – 31 March

2024.

What we have decided – in brief

The safeguard caps are still necessary. Royal Mail continues to hold a near-monopoly in delivering letters, and it has a very high share of the small and medium parcels sector. Therefore, we cannot rely on competition alone to protect consumers from significant price increases.

There is scope for some increase, while keeping prices affordable. Our evidence indicates that a 5%, real-terms increase to each of the caps would not make the Second Class products unaffordable, either for consumers generally or for a significant majority of potentially vulnerable consumers. But a larger increase would be unaffordable, because it could harm some vulnerable consumers.

1 Ofcom, 2018. Residential Postal Tracker 2018, July 2017-June 2018. QC3_1 and QG1. https://www.ofcom.org.uk/__data/assets/pdf_file/0034/118996/Residential-Postal-Tracker-Q3-2017-Q2-2018-tables.pdf. 2 There is one cap for standard letters and a separate ‘basket’ cap covering large letters and parcels, and each cap increases in line with the Consumer Prices Index each year.

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Raising the level of the standard letter cap will help to minimise the effect of the safeguard caps on Royal Mail’s pricing freedom so as to avoid a material effect on wider financeability. Our analysis shows that, if we do not raise the level of the standard letter cap, Royal Mail’s flexibility to increase prices could be eroded within two to three years. Royal Mail currently prices significantly below the level of the basket cap, which still gives it sufficient pricing flexibility over the products in the basket.

We have decided to increase the level of the standard letter cap by 5% in real terms, to 65p3; and to maintain the basket cap at its current level. These caps will ensure that the Second Class products remain affordable to consumers, while also giving Royal Mail an appropriate level of commercial flexibility. Each cap will increase by Consumer Prices Index (“CPI”) inflation on 1 April each year, until they expire on 31 March 2024 – or earlier, should we decide this is necessary.

This overview is a simplified, high-level summary only. The decisions we have taken, and our reasoning, are set out in the full document.

Royal Mail has a significant share for letters and parcels

1.7 The UK letters market is in decline, with total letter volumes falling by around 17% since

the caps were introduced in 2012/13, or 3% per year. Royal Mail’s stamped letter volumes

have fallen even faster, with volumes and revenues declining by around 11% and 7% per

year on average respectively.

1.8 Against this backdrop, our assessment shows that Royal Mail holds a near monopoly in

delivering letters. In the small and medium parcels sector, Royal Mail has a very high share

and an extensive access network and strong brand awareness. Combined, these give it

significant pricing power.

1.9 We cannot rely on competition alone to protect consumers from significant price

increases, so the safeguard caps are needed. In addition, we do not consider there has

been a change in competitive conditions that might prompt changes to the structure or

scope of the caps.

Retaining a safeguard cap to protect vulnerable customers

1.10 In setting the safeguard caps, we must ensure prices are affordable for residential

consumers and small businesses. We have particularly focused on the ability of potentially

vulnerable consumers4 to afford the Second Class products.

1.11 Measuring affordability for post is not straightforward. However, our analysis shows that

although spending on post is a low proportion of income, affordability issues may still arise

in circumstances where consumers either need to cut back on other essentials to send

3 The precise upper limit of the cap will be set at 65.2p from April 2019, however we note that currently Royal Mail charges in whole pence increments for the Second Class products. Therefore, when describing the level of the cap in this document, we round to the last whole pence (65p). 4 In assessing affordability we have considered each of the following groups, which we categorise as potentially vulnerable consumers: (i) over 65; (ii) without internet access; (iii) residing in rural areas; and (iv) in socio-economic group C2DE.

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post, or choose not to send post they consider essential. We have balanced a range of

evidence on affordability, and the likely effects on consumers, to come to a judgment on

the appropriate level of the safeguard caps.

1.12 In several areas, little has changed since we conducted our affordability assessment in

2013.5 Postal services still make up a low proportion of income, and our research suggests

most consumers do not experience affordability issues. However, real disposable incomes

have increased moderately since 2013, including for the lowest earners. This suggests

affordability has improved.

1.13 In our judgment, the evidence suggests that an increase of 5% in real terms above the

current level of each of the caps would not make the Second Class products unaffordable

for either consumers in general or most of those who are potentially vulnerable. The

potential for harm to some vulnerable consumers and evidence of changes since 2013

indicate that a larger increase than 5% should be considered unaffordable at this time.

Any changes to the standard letter cap should ensure Royal Mail has sufficient commercial flexibility to respond to threats to the universal service

1.14 We have found that the current levels of the safeguard caps have not prevented Royal Mail

from making a reasonable commercial rate of return on the safeguarded products.

1.15 Since the safeguard caps were introduced, Royal Mail has consistently chosen to price its

products below the level of the caps. When the caps were introduced in 2012/13, the

maximum permitted price of a Second Class stamp was 55p. Royal Mail chose not to price

to the level of the cap, instead pricing a Second Class stamp at 50p. This provided it with

pricing ‘headroom’ of approximately 10%. The current level of the cap now stands at 60p

and the price of a Second Class stamp is currently 58p. This means Royal Mail’s headroom

under the standard letter cap now stands at less than 5%, despite Royal Mail increasing

prices by only 1-2p per year on average since 2013. By contrast, Royal Mail currently has

headroom of approximately 29% under the cap for large letters and parcels up to 2kg,

which gives it considerable commercial flexibility.

1.16 While the level of commercial flexibility afforded by the basket cap is significant and

growing, the level of flexibility afforded by the standard letter cap has diminished over

time. Since 2013, for standard letters and large letters, Royal Mail has generally

implemented annual price increases at or around the Retail Prices Index (“RPI”). 6 RPI

inflation has generally been above CPI inflation, meaning that prices for Second Class

letters have increased slightly each year in real terms (when compared to CPI). Should the

level of the standard letter cap remain unchanged, it is likely that Royal Mail’s commercial

flexibility to increase prices in line with RPI inflation could be eroded within two to three

5 Ofcom, 2013. The Affordability of Universal Postal Services. https://www.ofcom.org.uk/__data/assets/pdf_file/0014/10445/affordability.pdf. 6 RPI is the inflation measure used by Royal Mail in its analysis of the postal sector.

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years. Our analysis shows that raising the level of the standard letter cap by 5% in real

terms will grant Royal Mail sufficient headroom and improve its ability to respond to

unforeseen market developments which could threaten the sustainability of the universal

service.

1.17 As set out in the Annual Monitoring Update on the Postal Market: Financial Year 2017/187

(“Annual Monitoring Update 2017/18”), we continue to consider that the universal service

is likely to remain financially sustainable in the immediate future. However, there are

various possible downside scenarios which have the potential negatively affect the

financial sustainability of the universal service. We will continue to monitor these closely.

1.18 Taking all of this together, we believe that raising the level of the standard letter cap by 5%

in real terms and maintaining the basket cap will give Royal Mail sufficient commercial

flexibility to make a reasonable commercial rate of return. This is necessary to avoid a

material effect on the universal service.

Our conclusions

1.19 In light of the findings, we have decided to raise the level of the Second Class standard

letter cap by 5% in real terms, which will take the upper limit of the cap from 60p currently

to 65p. This means Royal Mail can price Second Class standard letters up to a maximum of

65p from 1 April 2019 to 31 March 2020. The cap will continue to increase by CPI each

year on 1 April until the 31 March 2024.

1.20 This will re-establish a similar degree of pricing flexibility that Royal Mail had under the

Second Class standard letter cap in 2012, which will improve Royal Mail’s ability to respond

to unforeseen market developments. Raising the level of the standard letter cap should

ensure that Royal Mail has sufficient pricing flexibility, and that the cap does not have any

wider impact on the financial sustainability of the universal postal service.

1.21 We have decided not to adjust the level of the cap for Second Class large letters and

parcels up to 2kg, which will continue to increase each year by CPI on 1 April. Royal Mail

already has considerable pricing flexibility of approximately 29% under this cap, so it is not

necessary to increase the cap level further, despite the results of our affordability

assessment.

1.22 The caps will come into effect on 1 April 2019 and remain in force until 31 March 2024 – or

earlier, should we decide this is necessary.

7 Ofcom, 2018. Annual monitoring update on the postal market, Financial year 2017/18. https://www.ofcom.org.uk/__data/assets/pdf_file/0027/128268/Annual-monitoring-update-postal-market-2017-18.pdf.

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2. Introduction and summary of the regulatory framework

Structure of this statement

2.1 This statement concerns the regulation of the safeguard caps currently imposed in relation

to Royal Mail’s Second Class products. This follows a consultation we published in July 2018

(the “July 2018 Consultation”).8

2.2 In this section, we summarise Ofcom’s powers and duties relevant for our consideration

and assessment in coming to the decisions in this statement. We then summarise the

background to the review and the current regulatory framework for postal services, of

which the safeguard caps form a part. The remainder of this document sets out

stakeholder responses and our final decisions as follows:

• section 3 sets out our market analysis;

• section 4 sets out our assessment of affordability; and

• section 5 sets out our assessment of the commercial flexibility afforded to Royal Mail

under the caps.

2.3 Finally, section 6 sets out our final decisions and Annex 1 sets out the legal instruments

imposing the safeguard caps on Royal Mail from 1 April 2019.

Our powers and specific duties relevant to our decisions

2.4 The legal framework relating to the regulation of postal services is set out in the Postal

Services Act 2011 (the “PSA 2011”), which transposes the EU Postal Services Directive9 into

UK legislation.

2.5 Pursuant to the EU Postal Services Directive, the UK is required to ensure that prices for

each of the services forming part of the universal postal service are affordable, cost-

orientated and give incentives for an efficient universal services provision. In the UK, the

universal postal service is a set of services described in an order made by Ofcom under

section 30 of the PSA 2011 (the “Universal Service Order”) and it includes the Second Class

stamp products subject to the safeguard caps.10

8 Ofcom, 2018. Review of the Second Class Safeguard Caps 2019: Proposed price caps for Second Class standard letters, large letters and parcels up to 2kg. https://www.ofcom.org.uk/__data/assets/pdf_file/0021/116643/Review-Second-Class-Safeguard-Caps-2019.pdf. 9 Directive 97/67/EC of the European Parliament and of the Council of 15 December 1997 on common rules for the development of the internal market of Community postal services and the improvement of quality of service, as amended in particular by Directive 2002/39/EC and Directive 2008/6/EC. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:01997L0067-20080227&from=EN. 10 The Postal Services (Universal Postal Service) Order 2012, SI 2012/936, as amended by The Postal Services (Universal Postal Service) (Amendment) Order 2013, SI 2013/3108. See https://www.ofcom.org.uk/postal-services/information-for-the-postal-industry/upso.

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2.6 In 2012, Ofcom designated Royal Mail as the universal service provider and (among other

regulation) imposed upon it designated universal service provider (“DUSP”) conditions

using our powers under section 36 of the PSA 2011. The DUSP conditions are intended to

secure the provision in the UK of those services set out in the Universal Service Order. As

such, they form part of Royal Mail’s universal service obligations.

2.7 When setting tariffs, such as the safeguard caps, in relation to the provision of the

universal postal service, under section 36(4) of the PSA 2011, Ofcom must under section

36(5) seek to ensure that the prices of the relevant universal postal services:

• are affordable;

• take account of the costs of providing the service; and

• provide incentives to provide the service efficiently.

2.8 The decisions set out in this statement modify the existing DUSP conditions. In order to

impose or modify a regulatory condition, such as the DUSP conditions, we must be

satisfied, pursuant to Schedule 6 of the PSA 2011, that the imposition or the modification

in question must:

• be objectively justifiable;

• not discriminate unduly against particular persons or a particular description of

persons;

• be proportionate to what it is intended to achieve; and

• be transparent in relation to what it is intended to achieve.

2.9 Ofcom is also required to publish a notification setting out its proposals prior to imposing

or modifying a regulatory condition. That notification was published at Annex 5 to the July

2018 Consultation. In order to impose or modify a regulatory condition, Ofcom must

publish a notification setting out the condition or modification. We therefore set out the

effects of our modifications in section 6, and the notification itself is published at Annex 1.

2.10 Our power to impose or modify a regulatory condition is also subject to the specific duty in

section 29(1) of the PSA 2011, which provides that Ofcom must carry out its functions in

relation to postal services in a way that it considers will secure the provision of a universal

postal service.

2.11 Section 29(3) provides that, in performing its duty under section 29(1), Ofcom must have

regard to the need for the provision of a universal postal service to be:

• financially sustainable; and

• efficient before the end of a reasonable period and for its provision to continue to be

efficient at all subsequent times.

2.12 However, section 29 does not require that Ofcom gives more weight to one of those

considerations over the other. We must take them both into account in arriving at our

judgment as to how we ought to carry out our functions, including when considering

imposing or modifying regulatory conditions.

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General duties

2.13 Ofcom’s principal duty under section 3(1) of the Communications Act 2003 (the “CA 2003”)

is to further the interests of citizens and consumers, where appropriate by promoting

competition. This duty, in addition to our specific duty under section 29 of the PSA 2011,

also applies when we carry out our functions in relation to post. The CA 2003 also requires

that Ofcom must, in performing its principal duty, have regard to various factors as appear

to us relevant in the circumstances, such as the needs of persons with disabilities, of the

elderly and those on low incomes.11

2.14 In performing our principal duty, we must also have regard, in particular, to the interests of

consumers in respect of choice, price, quality of service and value for money. We must

further have regard, in all cases, to regulatory principles which should be transparent,

accountable, proportionate, consistent and targeted only at cases in which action is

needed, and any other principles appearing to us to represent the best regulatory practice.

2.15 Section 3(6A) of the CA 2003 provides that the duty in section 29(1) of the PSA 2011 takes

priority over Ofcom’s general duties in the CA 2003 in the case of conflict between the two,

where Ofcom is carrying out its functions in relation to postal services.

Securing the Universal Postal Service 2012

2.16 The current regulatory framework for postal services has been in place since March 2012,

when we established a new regulatory framework for postal services (the “2012

Statement”).12 We removed the previous price control regime implemented by Postcomm

in order to give Royal Mail greater commercial and operational flexibility, in recognition of

the major challenges facing the postal sector at that time.

2.17 In making that decision, we also recognised the risks associated with giving Royal Mail

greater pricing freedom. In particular, we were concerned that Royal Mail could seek to

improve its profitability through price rises alone and avoid tackling the considerable

efficiency challenge. There was also a related risk that Royal Mail raised prices to such an

extent that there could be affordability concerns for vulnerable consumers.

2.18 For these reasons, we concluded that, together with moving away from a price control-

based approach to regulation, vital safeguards needed to be put in place to ensure that

Royal Mail delivered on our regulatory objectives. We therefore put in place the following

new regulatory regime in 2012:

• an ongoing monitoring regime to track Royal Mail’s performance in respect of the

universal service, efficiency levels, pricing and competition;

11 CA 2003, section 3(4)(i). 12 Ofcom, 2012. Statement on Securing the Universal Postal Service: Decision on the New Regulatory Framework. http://stakeholders.ofcom.org.uk/binaries/consultations/review-of-regulatory-conditions/statement/statement.pdf.

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• safeguard caps including a cap on the price of Second Class stamps13 for standard

letters, and separately a basket cap for Second Class stamps on large letters and small

and medium parcels up to 2kg14; and

• access regulation to maintain access competition given the benefits it can bring, such

as lower prices for consumers.

2.19 This review is concerned with the safeguard caps only.

Introduction of the safeguard caps

2.20 The safeguard caps, introduced in 2012, seek to ensure a basic universal service is available

to all at affordable prices, and to ensure that users of postal services, especially vulnerable

consumers, are protected from significant price increases. Both safeguards caps are due to

expire on 31 March 2019.15

2.21 We considered that, if the safeguard caps ensured that a universal service product was

affordable to vulnerable consumers, it would also be affordable to all residential

consumers and small and medium businesses (“SMEs”) that were reliant on universal

services and Royal Mail to provide their postal services.

2.22 To ensure that the safeguard caps did not undermine the financial sustainability of the

universal service, we sought to minimise the impact of the caps on Royal Mail’s wider

pricing freedom and considered that Royal Mail should be allowed to make a reasonable

commercial rate of return on the safeguarded products.

2.23 We therefore adopted the following policy objectives in determining the appropriate

scope, level and duration of the safeguard caps (the “safeguard caps objectives”):

• ensure a basic affordable universal service product is available to all;

• protect vulnerable consumers from ongoing price increases;

• allow Royal Mail to make a reasonable commercial rate of return on the safeguarded product; and

• minimise the effect of the safeguard caps on Royal Mail’s pricing freedom so as to avoid a material effect on wider financeability and/or efficiency incentives16.

13 Unless otherwise specified, throughout this statement, references to Second Class stamps are references to traditional postage stamps or other types of labelling affixed to such items to indicate the amount of postage paid, including where the postage has been sold online. 14 The safeguard cap on Second Class stamp standard letters came into effect on 1 April 2012 and is imposed by DUSP Condition 2, as amended on 18 December 2017 (“DUSP 2”). An unofficial consolidated version of DUSP 2 is available via this link: https://www.ofcom.org.uk/__data/assets/pdf_file/0023/8339/dusp2.pdf. The safeguard cap on Second Class stamp large letters and parcels up to 2kg came into effect on 20 July 2012 and is imposed by DUSP Condition 3, as amended on 28 March 2013 and 18 December 2017 (“DUSP 3”). An unofficial consolidated version of DUSP 3 is available via this link: https://www.ofcom.org.uk/__data/assets/pdf_file/0019/8335/dusp3.pdf. The official legal instruments of DUSP 2 and DUSP 3, including their amendments, are referenced in the recitals to our notification published at Annex 1. 15 As provided for in DUSP 2 and DUSP 3. 16 When the safeguard caps were introduced in 2012, Royal Mail was in a weak financial position and the sustainability of the universal service was under severe pressure. The regulatory regime introduced in 2012 sought to address this by moving away from a price control-based approach to regulation towards the introduction of various safeguards, including the Second Class safeguard caps, which would grant Royal Mail greater commercial and operational flexibility. In this

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Scope and level of the cap on Second Class standard letters

2.24 In October 2011, we first consulted on whether a safeguard cap should be introduced with

respect to First and/or Second Class stamp products.17 On the basis of research and

evidence relating to the usage of stamp products, as well as the need to give Royal Mail

more pricing flexibility to secure the provision of the universal service, we proposed

limiting the scope of the safeguard caps to Second Class standard letters only.

2.25 In March 2012, we decided to impose a safeguard cap on Second Class standard letters set

at 55p for 2012/13.18 This represented a 53% increase on the stamp price at the time which

was 36p (2011/12 prices). The cap was to apply for seven years and is subject to indexation

at CPI19. As noted above, that safeguard cap is due to expire on 31 March 2019.

Addition of a basket cap for large letters and parcels

2.26 After a consultation in April 201220, we decided in July 2012 to extend the scope of the

safeguard caps to create an additional, separate basket cap comprising Second Class large

letters and small and medium parcels up to 2kg.21 We set the level of this basket cap to

allow for up to a 53% increase in the overall price of products within the cap (thereafter

increasing each year by CPI), in line with the level of price increase allowed for under the

standard letter cap. As noted above, this basket cap is also due to expire on 31 March

2019.

2.27 We considered that designing such a cap is slightly more complex compared to the cap

applied to Second Class standard letters, as Royal Mail offered large letter, packet and

standard parcel products at a variety of different weights. We decided to adopt a simple

basket cap that would give Royal Mail flexibility to set the structure of individual prices

subject to a cap on the maximum overall price increase for Second Class stamp large letters

and packet products22 up to 2kg.23

context, we note that the safeguard caps are not, in and of themselves, solely intended to provide efficiency incentives to Royal Mail. 17 Ofcom, 2011. Consultation on Securing the Universal Postal Service: Proposals for the Future Framework for Economic Regulation. https://www.ofcom.org.uk/__data/assets/pdf_file/0012/63003/Securing-the-Universal-Postal-Service-Proposals-for-the-future-framework-for-economic-regulation.pdf. 18 2012 Statement. See footnote 14 for DUSP 2. 19 In 2012 we decided to use CPI rather than RPI for future increases to the safeguard caps because CPI is considered to be a better measure of the costs incurred by vulnerable consumers, for example CPI is used as the basis for indexing benefits payments. 20 Ofcom, 2012. Consultation on Securing the Universal Postal Service: Safeguard Cap for Large Letters and Packets. https://www.ofcom.org.uk/__data/assets/pdf_file/0024/69063/condoc.pdf. 21 Ofcom, 2012. Statement on Securing the Universal Postal Service: Safeguard Cap for Large Letters and Packets. https://www.ofcom.org.uk/__data/assets/pdf_file/0015/72042/statement.pdf. (“2012 Basket Cap Statement”). See footnote 14 for DUSP 3. 22 Under Section 27(2) of the PSA 2011, ‘postal packet’ means a letter, parcel, packet or other article transmissible by post. 23 We also made some minor amendments to the basket cap on 28 March 2013 and 18 December 2017, respectively.

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Review of the Regulation of Royal Mail 2017

2.28 In June 2015, we initiated a Review of the Regulation of Royal Mail with the objective of

ensuring that the regulation of Royal Mail remained appropriate and sufficient to secure

the universal postal service (the “2017 Review”). We published a statement on our final

decision in March 2017 (the “2017 Statement”).24

2.29 In the 2017 Statement, we concluded that it was appropriate to maintain the current

regulatory approach for a further five years, until 2022. We considered that the imposition

of wholesale or retail price controls and/or efficiency targets on Royal Mail would not be

appropriate in order to secure the objectives of the regulatory regime. Rather, we

concluded that market conditions and the shareholder discipline which Royal Mail is

subject to as a privatised company are more likely to be effective in securing an efficient

and financially sustainable universal postal service than the imposition of additional

regulation.

2.30 We also concluded that the Second Class safeguard caps should remain in place to ensure

vulnerable consumers can access a basic universal service. This was on the basis that Royal

Mail continues to be a near monopolist in single piece letters and therefore has the ability

to profitably raise prices above the current level of the safeguard caps. In parcels, we

noted that Royal Mail’s significant share of the single piece parcel sector, combined with its

extensive access network and strong brand awareness, provides it with a significant degree

of pricing power. We therefore concluded that we could not rely on competitive

constraints to prevent Royal Mail from raising prices.

2.31 Data from our monitoring programme showed that Second Class revenue had increased at

a time when First Class revenue had fallen, which we considered may indicate that some

customers now favour cheaper Second Class products, perhaps due to price rises and the

desire to economise.25 We considered that this highlights the importance of maintaining

the safeguard caps as an affordability measure, in order to ensure that consumers, in

particular vulnerable consumers, continue to have access to a universal service at

affordable prices.

2.32 We concluded that the safeguard caps should be retained to ensure vulnerable consumers

can access a basic universal service. However, we also committed to review the level of the

safeguard caps during the course of the 2018/19 financial year, so we could take an

informed view based on the most up-to-date market information and any changes to the

financial sustainability of the universal service and/or the prices vulnerable consumers can

afford prior to the expiry of the safeguard caps in March 2019.26

24 Ofcom, 2017. Statement on Review of the Regulation of Royal Mail. https://www.ofcom.org.uk/__data/assets/pdf_file/0033/97863/Review-of-the-Regulation-of-Royal-Mail.pdf. 25 Ofcom, 2015. Annual Monitoring Update on the Postal Market: Financial Year 2014/15, page 56. https://www.ofcom.org.uk/__data/assets/pdf_file/0025/56923/annual_monitoring_update_2014-15.pdf. 26 2017 Statement, paragraphs 3.179 and 4.46.

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Royal Mail’s pricing behaviour since 2012

2.33 Following our change in approach to regulation in 2012, Royal Mail implemented

significant price increases (although still below the level of the caps) across its universal

service products in 2012 and 2013. Since then, for standard letters and large letters, it has

generally implemented smaller annual price increases at or around RPI27 – meaning that

prices for Second Class letters have increased slightly each year in real terms (when

compared to CPI). Figure 2.1 shows the percentage headroom under the safeguard caps

from 2012/13 to 2018/19. Figure 2.2 shows the prices of Second Class standard letter and

large letter products in nominal terms over the period 2011/12 to 2018/19.

Figure 2.1: Percentage headroom under the safeguard caps, 2012/13 to 2018/19

Source: Second Class safeguard cap compliance submissions as part of Royal Mail Regulatory Financial

Reporting Information.

27 RPI is the inflation measure used by Royal Mail in its analysis of the postal sector.

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Figure 2.2: Second Class standard letter and large letter nominal prices, 2011/12 to 2018/19

Source: Royal Mail published prices28/Ofcom Annual Monitoring Update analysis.29

2.34 For parcels, Royal Mail implemented size-based pricing in 2013 so that parcels were no

longer priced solely by weight but also by their dimensions. This involved differentiating

between small and medium sized parcels and led to substantial price increases for very

lightweight and medium format parcels. By consolidating the weight steps, Royal Mail also

reduced the price of some small but heavier weight Second Class stamp parcels in relation

to 2011/12 prices. In 2015, Royal Mail introduced a single price for 0-2kg for small and

medium Second Class parcels, which effectively reversed some of these price increases, as

shown in Figure 2.3. Since 2015, Royal Mail has generally implemented price increases for

its Second Class parcels products, broadly in line with RPI.

28 Prices obtained from Royal Mail website, for most recent price list see: https://www.royalmail.com/sites/default/files/Our-prices-2018-effective-26-March-2018.pdf. 29 For our most recent Annual Monitoring Update see footnote 7.

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Figure 2.3: Second Class small and medium parcel <2kg nominal prices, 2011/12 to 2018/1930

Source: Royal Mail published prices31/Ofcom Annual Monitoring Update analysis.32

2.35 Table 2.1 shows the impact of the price changes implemented since 2012 including how

the consolidation of prices for parcels weighing up to 2kg has caused the prices of parcels

at some weight steps to increase very significantly while others have fallen. For example,

medium parcels weighing 0-100g have increased in price by 280%, whereas small parcels

weighing 1-2kg have decreased in price by 33%. These changes are reflective of a change in

Royal Mail’s pricing strategy which now determines the price of sending a parcel by weight

rather than size. For example, whereas it used to be cheap to send a large and light parcel,

it is now more expensive.

30 In 2013, Royal Mail introduced new parcel products and size-based pricing. To enable comparison between the current Second Class parcel products, we use proxies based on Royal Mail’s most comparable previous parcel products. The line in this chart is dashed where we rely on these proxies. For small and medium parcels weighing less than 1kg, we use a proxy of Royal Mail’s Second Class packet product, which had a maximum dimension equivalent to a medium parcel. As this product was available at a range of weight steps up to 1kg, we use a weighted average price. Individual component prices were as follows: April 2011: £1.33 (0-100g), £1.72 (101-250g), £2.16 (251-500g), £2.61 (501-750g) and £3.15 (751-1000g); April 2012: £2.20 (0-750g) and £3.50 (751-1000g). For small and medium parcels weighing 1-2kg, we use of proxy of Royal Mail’s Standard Parcel up to 2kg. 31 Prices obtained from Royal Mail website, for most recent price list see footnote 28. 32 For our most recent Annual Monitoring Update see footnote 7.

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Table 2.1: Second Class stamp parcel prices, 2011/12 to 2018/19

Medium

Second

Class

2011/12

Price

Medium

Second

Class

2018/19

Price

% change to

price from

2011/12-

2018/19

Small

Second

Class

2011/12

Price

Small

Second

Class

2018/19

Price

% change to

price from

2011/12-

2018/19

0-

100g

£1.33 £5.05 280% £1.33 £2.95 122%

101-

250g

£1.72 £5.05 194% £1.72 £2.95 72%

251-

500g

£2.16 £5.05 134% £2.16 £2.95 37%

501-

750g

£2.61 £5.05 93% £2.61 £2.95 13%

751-

1kg

£3.15 £5.05 60% £3.15 £2.95 - 6%

1-2kg £4.41 £5.05 15% £4.41 £2.95 -33%

Source: Ofcom analysis of Royal Mail Second Class stamp parcel prices from 2011 to 2019, as at 17 January

2019.

Review of the Second Class safeguard caps 2019

The July 2018 Consultation

2.36 The July 2018 Consultation set out our proposals with respect to the level and scope of the

Second Class safeguard caps. In summary, we proposed to increase the standard letter

safeguard cap from its current level by 5% in real terms and to retain the level of the

basket cap, allowing each cap to increase by CPI each year thereafter. To give effect to

these proposals, in Annex 5 of the July 2018 Consultation, we set out a notification of our

suggested modifications to DUSP conditions 2 and 3, the legal instruments which impose

the safeguard caps. We considered that our proposals would enable us to achieve the

safeguard cap objectives, which we considered remained appropriate for our review.

Stakeholder responses to the July 2018 Consultation

2.37 We received eight responses to our July 2018 Consultation. The stakeholders that

responded were: Citizens Advice, Citizens Advice Scotland (“CAS”), the Consumer Council

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Northern Ireland (“CCNI”)33, Hermes UK, the Mail Competition Forum (“MCF”), Royal Mail

plc, Sterling Technical Services Ltd (“Sterling”)34 and Whistl UK Limited.

2.38 We have considered all submissions made by stakeholders in their responses, and have

summarised and addressed these points in the relevant sections of this statement. Non-

confidential versions of all the responses received are published on the Ofcom website.35

Evidence-gathering process for this review

2.39 In carrying out our analysis for the purposes of this review, we have relied on several

sources of evidence, including:

• data from a Residential Omnibus Survey36 commissioned by Ofcom in April 2018

relating to consumers’ postal expenditure and sending patterns (“Residential Omnibus

Survey”);

• data from Ofcom’s Business Postal Tracker 2018 relating to January-December 201737

in the July 2018 Consultation and to July 2017-June 201838 in this statement, and April

201839 on small and medium business’ postal expenditure and sending patterns

(“Business Postal Tracker”);

• data from Ofcom’s Residential Postal Tracker 2018 on usage and affordability relating

to January-December 201740 in the July 2018 Consultation and to July 2017-June 201841

in this statement (“Residential Postal Tracker”);

• data on household disposable incomes, expenditure on postal services, expenditure on

other comparator items and household expenditure from the Office for National

Statistics’ (“ONS”) Living Costs and Food Survey42;

33 In addition to the points raised by CCNI and discussed in this statement, CCNI also submitted that we should monitor the effect of the safeguard caps on consumers. We note that our monitoring regime includes monitoring affordability to ensure services remain affordable. 34 We understand that the comments submitted by Sterling relate to the provision of stamps by different dominations. As explained in this statement, the level of the safeguard caps is set to address affordability concerns, as well as to allow Royal Mail sufficient commercial flexibility to ensure the provision of a sustainable universal service. We consider that the issue raised by Sterling is a matter for Royal Mail to decide and, on this occasion, it would be disproportionate for us to act in this respect. 35 Stakeholder responses to the July 2018 Consultation are available at: https://www.ofcom.org.uk/consultations-and-statements/category-1/review-second-class-stamp-safeguard-cap. 36 Ofcom, 2018. Residential Omnibus Survey 2018. https://www.ofcom.org.uk/__data/assets/pdf_file/0028/116596/Residential-omnibus-survey.PDF. 37 Ofcom, 2018. Business Postal Tracker 2018, January-December 2017. https://www.ofcom.org.uk/__data/assets/pdf_file/0023/111695/Business-Postal-Tracker-Q1-Q4-2017-tables.pdf. 38 Ofcom, 2018. Business Postal Tracker 2018, July 2017-June 2018. https://www.ofcom.org.uk/__data/assets/pdf_file/0032/118994/Business-Postal-Tracker-Q3-2017-Q2-2018-weighted-tables.pdf. 39 Ofcom, 2018. Business Postal Tracker 2018, April 2018. https://www.ofcom.org.uk/__data/assets/pdf_file/0029/116597/Business-postal-tracker.PDF. 40 Ofcom, 2018. Residential Postal Tracker 2018, January-December 2017. https://www.ofcom.org.uk/__data/assets/pdf_file/0020/111692/Residential-Postal-Tracker-Q1-Q4-2017-tables.pdf. 41 Ofcom, 2018. Residential Postal Tracker 2018, July 2017-June 2018. See footnote 1. 42 ONS, 2018. Living Costs and Food Survey. See: https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/expenditure/bulletins/familyspendingintheuk/financialyearending2017 and

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• data received from Royal Mail in response to an information notice sent on 15 May

2018, pursuant to our information gathering powers under section 55 of the PSA 2011,

relating to Royal Mail’s pricing decisions, consumer research, price- and cross-

elasticities and costs (“s.55 Notice”); and

• data received from various parcel operators in response to an information notice sent

on 13 April 2018, pursuant to our information gathering powers under section 55 of

the PSA 2011, relating to volumes and revenues (“s.55 Market Data Notices”).

The January 2019 statement

2.40 This statement concludes our review and sets out our decisions for the continued

regulation of the Second Class products, taking account of up-to-date market information

and our latest assessment of the commercial flexibility afforded to Royal Mail by the

safeguard caps and of the prices we consider vulnerable consumers can afford. We

continue to believe that the safeguard cap objectives remain appropriate for our review

and consider that the decisions set out in this statement secure those objectives.

General impact assessment

2.41 The analysis presented in this statement represents in its entirety an impact assessment, as

defined in section 7 of the CA 2003.

2.42 Impact assessments provide a valuable way of assessing different options for regulation

and showing why the preferred option was chosen. They form part of best practice policy

making. This is reflected in section 7 of the CA 2003, which means that generally Ofcom

has to carry out impact assessments where its proposals would be likely to have a

significant effect on businesses or the general public, or when there is a major change in

Ofcom’s activities. However, as a matter of policy Ofcom is committed to carrying out and

publishing impact assessments in relation to the great majority of its policy decisions. For

further information about Ofcom’s approach to impact assessments, see our guidelines,

Better Policy Making: Ofcom’s approach to Impact Assessment.43

2.43 Specifically, pursuant to section 7, an impact assessment must set out how, in our opinion,

the performance of our general duties (within the meaning of section 3 of the CA 2003) is

secured or furthered by or in relation to what we impose.

Equality impact assessment

2.44 In carrying out our functions, including with regard to the safeguard caps considered in this

review, we are also under a general duty under the Equality Act 2010 to have due regard to

the need to:

https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/theeffectsoftaxesandbenefitsonhouseholdincome/financialyearending2017. 43 Ofcom, 2005. Better Policy Making: Ofcom’s Approach to Impact Assessment. For further information see our website: https://www.ofcom.org.uk/consultations-and-statements/better-policy-making-ofcoms-approach-to-impact-assessment.

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• eliminate unlawful discrimination, harassment and victimisation;

• advance equality of opportunity between different groups; and

• foster good relations between different groups

in relation to the following protected characteristics: age; disability; gender reassignment;

pregnancy and maternity; race; religion or belief; sex and sexual orientation.

2.45 Such equality impact assessments also assist us in making sure that we are meeting our

principal duty under section 3 of the CA 2003 mentioned above.

2.46 We have therefore considered what (if any) impact our decisions in this statement may

have on equality. Having carried out this assessment, we are satisfied that our decisions

are not detrimental to any group defined by the protected characteristics set out in

paragraph 2.44 above.

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3. Market analysis

Introduction and summary

3.1 This section assesses the market context and competitive constraints in the segments of

the postal market where the safeguard caps apply. We discuss the single piece standard

letter, large letter and parcel market segments in turn. We focus on the competitive

constraints in each of these market segments, from both the supply and demand side. We

also consider interactions between the different products within scope of the caps.44

3.2 We last carried out an assessment of competitive dynamics in the letter and parcel sectors

in our 2017 Review referred to in section 2 of this statement. The 2017 Review concluded

in particular that we could not rely on competitive constraints to prevent Royal Mail from

raising prices for single piece letters and parcels. We therefore decided that it would be

necessary to retain the safeguard caps to ensure vulnerable consumers can continue to

access a basic universal service at an affordable price.

3.3 Our July 2018 Consultation set out our view that competitive constraints had not changed

since we concluded our 2017 Review. Having considered stakeholder responses to the July

2018 Consultation, we remain of the view that competitive constraints are insufficient to

prevent Royal Mail from raising the prices of the safeguarded products significantly, and

that a safeguard cap continues to be necessary. Also, we do not think there has been a

change in competitive conditions that would suggest altering the structure or scope of the

safeguard caps.

3.4 This section summarises our consultation position and stakeholder responses, and sets out

our conclusions on the market analysis having taken responses into account.

Standard letters

Our consultation proposal

3.5 In our July 2018 Consultation, we proposed that Royal Mail remained a near-monopolist in

the provision of single piece standard letters. In our view, whilst the risk of accelerating e-

substitution may have caused Royal Mail to be cautious in implementing larger price

increases, there was limited evidence that e-substitution represented a meaningful

constraint on Royal Mail’s ability to profitably raise prices for single piece letters

(particularly with respect to smaller price increases). We therefore remained of the view

44 In exercising our powers under section 36 of the PSA 2011 to impose or modify the safeguard caps under the DUSP conditions, we are not required to carry out a market analysis and to assess market power in accordance with the principles of competition law. To conduct this review, we do not consider it necessary to formally define relevant markets or reach findings on the existence of any positions of dominance. We focus instead on an assessment of the extent of competitive constraints in the market segments in question, particularly to inform our understanding of the extent to which market forces might impact on Royal Mail’s ability to set its prices for the products covered by the safeguard caps.

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that Royal Mail faced only limited competitive constraints on its prices for single piece

letters.

Stakeholder responses

3.6 Consumer groups45 and MCF agreed with our market analysis, and said that competitive

constraints were insufficient to prevent Royal Mail from raising prices for standard letters.

3.7 Royal Mail disagreed with our market analysis. It argued that the letters market was

significantly more competitive than we had suggested, setting out three key factors that

demonstrated it was materially constrained in its pricing:

a) It argued that e-substitution was a potent form of competition. It considered that price

increases may be profitable in the short run, but it could encourage consumers to

permanently switch away from mail, predominantly to digital alternatives, and so harm

long-run profitability. It considered this risk created an incentive for Royal Mail to

maintain a prudent pricing policy.

b) It argued that significant price increases substantially increased the risks of triggering a

“tipping point”, leading to substantial reductions in letter volumes, as experienced in

other European countries such as Denmark and the Netherlands. It said the its prudent

pricing policy reflected this risk.

c) It argued that a growing trend of access operators offering services directly to

residential consumers and small businesses provided an additional constraint.

3.8 We set out our assessment of competitive constraints in standard letters below, taking into

account the stakeholder responses we received.

Our assessment

Context

3.9 Within the single piece letters sector, there are two main standard letter products46 which

are available to consumers for domestic services: Royal Mail’s First and Second Class

universal letters services. Businesses are likely to have access to a wider range of products

including meter mail (which is also within the scope of the universal service, but outside

the scope of the safeguard cap) or bulk mail, subject to meeting minimum volume

thresholds.

3.10 Customers can pay for universal postal services in three main ways: stamps47, meter and on

account. Paying by meter allows customers to access cheaper prices, but is usually only

suitable for higher volume users due to the cost of investing in a meter.

45 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI. 46 Royal Mail specifies that standard letters weigh no more than 100g and have maximum dimensions of: 24cm x 16.5cm x 5mm. 47 As noted in section 2, this includes postage purchased online, though for standard letters this is priced the same as a stamp purchased in person.

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3.11 Overall standard letter volumes have been in decline. Royal Mail’s end-to-end standard

letter stamp volumes fell by around 11% per year on average from 2012/13 to 2017/18

(revenues fell by 7% per year on average). This decline was consistent across First Class and

Second Class letters, though higher than the volume and revenue decline across all stamp,

meter and account letters (which was around 8% and 5% respectively per year on average

over the same period).48

3.12 A significant contributor to this declining trend is e-substitution – the replacement of

communications previously sent by mail with electronic alternatives. This is a structural

change occurring as technology has enabled alternative means of communicating. This

process of switching from physical mail to electronic communication would be likely to

occur to a large extent independently of pricing and competition in the letters sector. Once

any initial set up costs are incurred, the incremental cost of electronic communications is

very low. However, we note there may be other barriers to the use of e-substitutes, such

as internet literacy or access, which may constrain the extent they present viable

alternatives for some users. Royal Mail argued that significant price increases could lead to

a tipping point or step-change in the rate of e-substitution, particularly for larger users. In

our 2017 Review, we concluded that there was limited evidence that e-substitution

represented a meaningful constraint on Royal Mail’s ability to profitably raise prices,

particularly for moderate price increases.

Supply-side constraints

3.13 Royal Mail remains a near-monopolist in Second Class single piece stamped standard

letters. It is the only operator offering these end-to-end services on a national scale,

although there are a number of smaller scale end-to-end operators delivering in specific

geographic areas. We continue to estimate that Royal Mail has a volume share of over 99%

in single piece letters. We estimated in 2017/18 that just 0.1% of total addressed letters

volumes were delivered by end-to-end operators other than Royal Mail.49

3.14 As discussed in our 2017 Review, following Whistl’s exit from end-to-end delivery in 2015,

we do not consider that there is likely to be another end-to-end entrant of sufficient scale

and scope to provide a significant level of letter delivery competition to Royal Mail in the

foreseeable future. As the prospect of significant rival entry has diminished, potential

constraints on Royal Mail are weaker than when the safeguard caps were introduced in

2012, when the prospect of end-to-end entry and expansion was more credible.

3.15 In its consultation response, Royal Mail pointed out that some access operators have

started offering services directly to residential and small business customers, specifically:

a) Royal Mail referenced Whistl offering such a service through parcel2go.com. However,

this service requires a minimum spend of £20+VAT and so is only suitable for sending

multiple letters at the same time. This means it is unlikely to be a suitable alternative

48 Royal Mail Regulatory Financial Reporting Information. 49 Annual Monitoring Update 2017/18, paragraph 3.14.

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for many users of single piece letters, as particularly residential consumers are unlikely

to reach this minimum spend threshold. Our Residential Omnibus Survey suggests just

1% of consumers spent over £20 on letters in the last month,50 and our Residential

Postal Tracker indicates that just 12% of consumers spent over £20 on postage in

total.51

b) Royal Mail also gave the example of Cornwall Collects, a partnership between Whistl

and Imprimus offering collection services to businesses in Cornwall. However, this

service is only available to business users in a limited geographical area.

3.16 These services are only likely to be viable substitutes for a small subset of users of single

piece letter services. Therefore, we consider that constraints from these services on the

prices of single piece letters are likely to be very limited.

3.17 Accordingly, we continue to consider that neither existing competitors nor the threat of

future entry are likely to constrain Royal Mail’s pricing for Second Class stamps for

standard letters.

Demand-side constraints

3.18 A consumer or business considering sending a Second Class standard letter using a stamp,

has, in theory, the following main alternative mail or non-mail options:

• sending the item using a Royal Mail First Class stamp;

• sending the item using a different Royal Mail payment method (for example a meter

product) or a competing provider using Royal Mail access products, subject to meeting

the necessary volume threshold; and/or

• not sending the item by mail, possibly due to sending it using an alternative electronic

form of communication.

Alternative mail products

3.19 Alternative mail products do not provide a direct competitive constraint on Second Class

stamps, as Royal Mail is also the only (retail or wholesale) provider of these alternatives.52

Accordingly, switching between these products does not necessarily affect Royal Mail’s

overall profitability, and it is able to set prices across products to maximise overall

revenues.

3.20 Interdependencies between products could affect Royal Mail’s pricing decisions and may

lead to some degree of indirect competitive constraint, to the extent that other products

are constrained by alternatives (that do not involve Royal Mail at retail or wholesale levels)

and there are interlinkages between these products and Second Class stamps.

3.21 Royal Mail’s main alternative stamp product to Second Class is its First Class stamp

product. This provides a superior service to Second Class (delivery within one working day

50 Residential Omnibus Survey, Q1. 51 Residential Postal Tracker 2017/18, QD4. 52 Except in very limited cases of smaller scale end-to-end operators delivering in specific geographic areas.

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compared to three working days) and is priced higher to reflect this. This price differential

affects switching between the two products, and Royal Mail has chosen to maintain a price

differential of around 9p in recent years.

3.22 Alternative payment methods (such as a meter product) are only likely to be a viable

option for businesses, given that customers need to send significant volumes of letters for

it to be economic to incur the upfront cost of a meter machine. Again, Royal Mail has

historically maintained a differential between stamp and meter prices, and the level of this

differential affects switching between the products.

3.23 If managing switching between products is desirable to Royal Mail, this may mean it would

not implement a standalone price increase for Second Class stamps. However, this would

be unlikely to constrain a general increase in prices across products that maintained

differentials. This is how Royal Mail has historically implemented price changes, and

evidence from Royal Mail’s internal documents shows that broadly maintaining

differentials between products is a consideration when setting prices.53

3.24 Further, these interlinkages would only provide an indirect competitive constraint if some

linked products were constrained by other alternatives that do not involve Royal Mail. For

higher volume users, Royal Mail’s meter and bulk products may face some competition

from operators using access products. If this constrains meter pricing, this may in turn

affect the pricing of stamp products to the extent that maintaining differentials between

products is important. However, this indirect constraint is not likely to be strong. Only a

small subset of customers would send sufficient volumes of mail to make them attractive

to a competing access provider.54 In any case, Royal Mail retains the vast majority of

revenues from letters delivered via access products.

E-substitution

3.25 In response to our July 2018 Consultation, Royal Mail argued that our market analysis

understated the extent to which e-substitution constrained its ability to raise prices.

3.26 Switching to a digital alternative may have upfront costs for some consumers – for

example buying a smart phone or putting in place an electronic customer communications

platform (such as a business investing in new systems). However, for consumers who

already have the means of using an electronic alternative the incremental cost is very low

and would be substantially cheaper than using postal services.

3.27 As we concluded in our 2017 Review, e-substitution has led to a decline in single piece

standard letter volumes, including Second Class stamps. Royal Mail argued that

technological advances have led to customers using less mail, which constrains its pricing.

3.28 We agree that there is a clear decline in letter volumes, at least in part driven by the use of

electronic alternatives. However, Royal Mail has not provided additional evidence to

53 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 54 As discussed above, Whistl’s service offered through parcel2go.com requires a minimum spend greater than typical monthly spend for almost all consumers.

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demonstrate that volume decline due to e-substitution would necessarily indicate a pricing

constraint. We remain of the view that the structural decline in standard letters means

that falling volumes do not necessarily represent responses to price increases. Ongoing

volume and revenue decline is not necessarily evidence of constraints on pricing. Once in

place electronic alternatives have a substantially lower cost than post at current prices. A

further price increase in post would therefore be unlikely to trigger substantial additional

switching for those customers that have electronic alternatives in place, as there is already

a significant differential between post and electronic alternatives. As 87% of consumers

have internet access,55 this is likely to be the case for the majority of consumers.

3.29 For consumers who would need to incur upfront costs before switching to a digital

alternative, this may be more likely in response to a significant stamp price increase that

might trigger such an investment. Royal Mail argues that the risk that consumers could

switch away permanently has caused it to implement a prudent pricing policy. It notes that

it is actively seeking to avoid ‘tipping points’ experienced by other European postal

operators where volumes have fallen dramatically.

3.30 We consider that specific individual circumstances have influenced the rate of e-

substitution in the examples cited by Royal Mail. For example, in Denmark, the

government implemented a Digital Post Strategy whereby citizens received official

correspondence from the public sector digitally. However, we do agree that these risks

may lead Royal Mail to act somewhat conservatively, as it may be uncertain about the level

of price increase that might contribute to triggering additional e-substitution or ‘tipping

points’. Royal Mail’s internal documents on their pricing decisions demonstrate a

consideration that larger price increases may have a greater risk of triggering e-

substitution.56

3.31 In addition, there may be several factors that affect the likelihood of e-substitution for

certain customers or mail types. A lack of e-literacy could be a barrier to some consumers

using electronic alternatives, whilst businesses would need to both invest in systems and

gain customer consent to switch to communicating electronically. Additionally, it is likely

that there will remain a proportion of standard letters for which digital alternatives are not

a good alternative. For example, Royal Mail has estimated that e-substitution rates are

higher for transactional and advertising mail ([]% per annum) than for social mail ([]%

per annum)57, suggesting that e-substitution is more likely for certain letter types.

3.32 Absent very significant price increases, it is not clear that Royal Mail’s prices have a

significant impact on the rate of e-substitution. There is limited evidence that e-

substitution represents a meaningful constraint on prices. Royal Mail’s price increases have

historically been profitable, accounting for structural decline due to ongoing e-

55 Ofcom, 2018. Communications Market Report 2018: United Kingdom, Figure 1.3. https://www.ofcom.org.uk/__data/assets/pdf_file/0022/117256/CMR-2018-narrative-report.pdf. 56 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 57 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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substitution.58 Royal Mail’s internal documents demonstrate that price increases for

stamped letters have generally translated into average unit revenue increases.59

Price sensitivity

3.33 In this sub-section, we consider the available evidence on whether mail consumers are

sufficiently sensitive to price increases to make it unprofitable for Royal Mail to increase its

Second Class stamp price. Initially, we consider responses to consumer surveys, although

these tend to overstate the responsiveness to price increases. Then we consider Royal

Mail’s own estimates of price sensitivity (the elasticity of demand – the ratio of the

percentage change in volume to a percentage change in price).

3.34 Our market research suggests that, in general, a small minority of consumers are price

sensitive in relation to letters. 10% of residential consumers said they would send fewer

standard letters and large letters in response to a 10% price increase and a further 2% said

they would not send any letters because the price would be unaffordable. 14% said they

would send fewer letters, and 3% said they would not send any, in response to a 20% price

increase.60

3.35 Amongst businesses, 35% said they would send fewer letters in response to a 10% price

increase and 1% said they would not send any letters. 52% said they would send fewer

letters in response to a 20% price increase, and 3% said they would not send any.61 This

includes a significant proportion who said they would switch to electronic alternatives

where they could (29% and 48% respectively). However, only 4% of businesses said they

had responded to recent moderate postage price rises by sending fewer letters.62 Of

businesses that had recently decreased their volume of post, only 12% cited cost as the

reason.63 This supports a view that, for businesses, moderate increases are less likely to

trigger a significant reduction in volumes, but significant increases may lead them to

consider implementing electronic alternatives.

3.36 These survey responses provide mixed evidence on whether a price increase would be

unprofitable. We treat, however, this evidence from market research with a degree of

caution, given that survey responses to hypothetical questions, such as the ones

mentioned above, have a tendency to overstate actual price responsiveness. In addition,

our research does not provide an indication of the extent of volume response envisaged by

those who would send fewer letters.

3.37 Royal Mail’s own elasticity estimates suggest that social and transactional mail are price

inelastic, and transactional mail has a low elasticity for small price changes ([]). Royal

58 2017 Statement, paragraph 3.118. 59 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 60 Residential Omnibus Survey, Q9 and Q10. Question concerned letters, so covers both standard and large letters. 61 Business Postal Tracker, QN7a and QN7b. Question concerned letters, so covers both standard and large letters. 62 Business Postal Tracker, QN8. 63 Business Postal Tracker, QS3a.

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Mail estimate social and transactional mail make up over 95% of Second Class Stamp letter

volumes.64

3.38 Our survey results may suggest consumers are more price sensitive than Royal Mail’s

estimates of price sensitivity. We have noted potential issues in interpreting answers to

hypothetical survey questions, whereas Royal Mail’s estimates are based on actual

consumer behaviour. Accordingly, in this instance, we think Royal Mail’s estimates are

likely to better reflect the reality in this regard. This evidence suggests that, particularly for

residential consumers, few would respond to a significant price increase for a Second Class

standard letter by choosing not to send the item. Substantial price increases may increase

the likelihood of businesses considering electronic alternatives. Accordingly, we consider

that price sensitivity is unlikely to competitively constrain Royal Mail’s prices, particularly

for price increases in line with those Royal Mail has implemented in recent years.

Royal Mail’s pricing behaviour

3.39 Our 2012 Statement introduced a safeguard cap for standard letters at 53% above

prevailing prices, with subsequent annual increases by CPI. In 2012, Royal Mail

implemented significant increases in standard letter prices in the first year of the new

safeguard caps, though not up to the level of the safeguard cap. Since this increase, Royal

Mail has implemented price increases for standard letters of around RPI each year. As RPI

inflation has generally been above CPI inflation, this has led to a gradual narrowing of the

headroom under the safeguard cap. Royal Mail’s current prices remain 5% below the cap,

though it has effectively used most of the headroom granted in 2012.

3.40 As we concluded in our 2017 Review, Royal Mail’s price increases for letters have

historically been profitable. Royal Mail’s internal documents indicate that it generally

expects that moderate price increases for single piece letters would be revenue

enhancing.65 Though the cap for standard letters is not currently binding, there is little

evidence that prices are constrained by competition, or that further price increases would

not be profitable.

3.41 Royal Mail’s response argues that its recent moderate price increases for letters

demonstrate that it is materially constrained in its pricing. However, we consider Royal

Mail’s pricing approach of implementing regular relatively small price increases is

consistent with the existence of limited constraints for such price increases. This is also

consistent with greater uncertainty about the potential impact of larger price increases,

including the potential risk of triggering a step-change in the rate of e-substitution or

‘tipping points’ due to large, repeated price increases.

3.42 As in our 2017 Review, we continue to consider that political pressure, negative publicity

and our monitoring regime act as additional constraints on Royal Mail’s pricing of single

64 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 65 For example, documents prepared for the consideration of 2018/19 price changes suggested that []. Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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piece letters to some extent. This is supported by considerations in Royal Mail’s internal

documents, which highlight the risk of political intervention or negative publicity as part of

a range of factors taken into account when considering stamp price increases.66 This,

however, does not mean that Royal Mail would be unable to continue to profitably

increase prices, though it may choose to manage uncertainty by implementing changes in a

gradual manner.

Conclusion on competitive constraints on standard letters

3.43 Royal Mail remains a near-monopolist in the provision of single piece standard letters.

Whilst the risk of accelerating e-substitution may cause Royal Mail to be cautious in

implementing larger price increases, there is limited evidence that e-substitution

represents a meaningful constraint on Royal Mail’s ability to profitably raise prices for

single piece letters (particularly with respect to smaller price increases). We therefore

remain of the view that Royal Mail faces only limited competitive constraints on its prices

for single piece letters.

Large letters

Our consultation proposal

3.44 In our July 2018 Consultation, we proposed that Royal Mail remains a near-monopolist in

the provision of single piece large letters. In our view, whilst the risk of accelerating e-

substitution may have caused Royal Mail to be cautious in implementing significant price

increases, there was limited evidence that e-substitution represented a meaningful

constraint on Royal Mail’s ability to profitably raise prices for single piece large letters

(particularly with respect to smaller price increases). We therefore remained of the view

that Royal Mail faced only limited competitive constraints on its prices for single piece

large letters.

3.45 Our assessment was that Royal Mail continued to have a significant degree of pricing

power in single piece large letters. We considered that, absent regulation, Royal Mail

would be able to increase its prices materially. However, in our view, uncertainty about e-

substitution may act to limit the scale of price increases implemented at one time.

Stakeholder responses

3.46 In relation to competition in large letters, respondents made the same arguments as for

standard letters. Consumer groups67 and MCF agreed that competitive constraints were

insufficient to prevent Royal Mail from raising prices for large letters. Royal Mail disagreed,

and argued that e-substitution, tipping points and access operators provided material

constraints on its pricing.

66 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 67 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI.

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3.47 We set out our assessment of competitive constraints in large letters below, taking into

account stakeholder responses we received.

Our assessment

Context

3.48 Products within the large letter68 sector mirror those described above for standard letters –

i.e. there are stamp, meter and online variants although the stamp and online variants are

priced identically. Meter products are cheaper by comparison. The prices of large letter

products also vary by weight step.69 As well as being used to deliver larger paper items,

large letters are also used for sending other lightweight, flat items.

3.49 Overall, large letter volume trends show a small increase in large letter Second Class stamp

volumes and revenues from 2012/13 to 2017/18 – 2% and 4% respectively on average per

year. First Class stamp large letter volumes showed a moderate decline (6% in volumes and

4% in revenues on average per year).70 As residential consumers use large letters relatively

infrequently, this trend may be driven by businesses downtrading to Second Class products

as the price of both First and Second Class stamps has increased.

3.50 As with single piece standard letters, e-substitution is leading to the decline in some types

of large letter volumes, and this is at least somewhat independent of pricing. The increase

in Second Class large letter volumes may reflect the use of large letters for fulfilment, and

the increase in volume of mail sent for this purpose.

Supply-side constraints

3.51 We consider that supply side constraints for large letters are the same as those for

standard letters. Royal Mail remains a near monopolist and the only operator offering

these services on a national scale. The prospect of significant rival end-to-end entry has

diminished. As discussed for standard letters, Royal Mail highlighted services offered by

access operators directly to residential and small business customers. These services would

only be suitable for a small subset of uses of single piece letter services and therefore we

consider that constraints from these services are likely to be very limited. Accordingly, we

remain of the view that neither existing competitors nor the threat of future entry are

likely to constrain Royal Mail’s pricing for Second Class stamps for large letters.

Demand-side constraints

3.52 A consumer or business considering sending a Second Class large letter using a stamp, has

the following main alternative options:

• send using a different Royal Mail First Class stamp product;

68 Royal Mail large letters can weigh no more than 750g and maximum dimensions cannot exceed 35.3cm x 25cm x 2.5cm. 69 These are 0-100g, 101-250g, 251-500g and 501-750g. 70 Royal Mail Regulatory Financial Reporting Information.

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• send using a different Royal Mail payment method (e.g. meter) or a bulk provider,

subject to minimum volume thresholds;

• reformat the item so that it can be sent as a standard letter; and/or

• not sending the item by mail, possibly due to sending it using an alternative electronic

form of communication.

Alternative mail products

3.53 As discussed above for standard letters, Royal Mail maintains differentials between its

Second Class large letter stamp prices and its other large letter products to manage

switching between products. As for standard letters, whilst this may constrain standalone

price increases in Second Class stamp prices, it would be unlikely to constrain a general

increase in prices across products.

Reformatting the item

3.54 Customers sending a large letter-sized item may be able to reformat the item so that it

could be sent as a cheaper standard letter. Therefore, standard letter prices may provide

some constraint. However, this would only be suitable for some items sent by large letter.

Given the current price differentials between these product sets, it is likely that this would

have already occurred if it could be done at a low cost, and further moderate widening of

the price differential is unlikely to trigger significant additional reformatting. This

constraint on large letter pricing is therefore likely to be small.

3.55 In addition, whilst this effect may constrain a standalone increase in price to a limited

extent, this would be unlikely to constrain a general increase across standard letters and

large letters. Royal Mail’s historic pricing behaviour and internal documents indicate that it

takes a coordinated approach to pricing its products to avoid this risk.71

E-substitution and price sensitivity

3.56 As for standard letters, Royal Mail argued that our market analysis understated the extent

to which e-substitution constrained its ability to raise prices. We remain of the view that,

whilst e-substitution may be driving some decline in volumes, this is not necessarily a

result of price increases. Absent very significant price increases, it is not clear that Royal

Mail’s prices have a significant impact on the rate of e-substitution. Market research

suggests that many residential customers are not very price sensitive. Royal Mail elasticity

estimates are also low.72 This suggests that Royal Mail could implement further price

increases without having a significant impact on volumes.

71 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 72 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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Parcels

Our consultation proposal

3.57 In our July 2018 Consultation, we proposed that Royal Mail’s strong market position,

widespread access network, 73 VAT exemption74 and strong brand recognition gave it a

significant degree of pricing power for Second Class parcels weighing up to 2kg. In our

view, this was greater still for small and lightweight items that can fit through a letter box,

as Royal Mail has cost advantages for these items due to its established integrated parcel

and letter delivery network. We remained of the view that we could not rely on

competitive constraints to prevent Royal Mail from raising prices for the parcel products

subject to the safeguard cap. Whilst Royal Mail was not pricing to the cap, it had made use

of a significant proportion of the headroom under the cap and had tended to increase

prices roughly in line with RPI in recent years. We considered that the risk of unforeseen

responses to their pricing strategy may lead Royal Mail to act conservatively.

3.58 Our assessment was that Royal Mail continued to have a significant degree of pricing

power in small and medium parcels up to 2kg. We considered that, absent regulation,

Royal Mail would be able to increase prices materially. However, in our view, uncertainty

about e-substitution (in letters) or competitor responses (in parcels) may have acted to

limit the scale of price increases implemented at one time.

Stakeholder responses

3.59 Consumer groups75 and MCF agreed with our market analysis, and said that competitive

constraints were insufficient to prevent Royal Mail from raising prices for small and

medium parcels up to 2kg. Consumer groups also highlighted that some consumers may be

less able to switch to alternative providers if they live in areas with fewer alternative access

points.

3.60 Royal Mail disagreed with our market analysis. It argued that our analysis understated the

degree of competition in the parcels sector and the extent to which it constrains Royal

Mail’s pricing for single piece parcels. It set out three factors that it considered

demonstrated that it was materially constrained in its pricing for single piece parcels:

a) It argued that investment in new facilities by parcel competitors had generated spare

capacity, which places downward pressure on Royal Mail’s prices. It also argued that

extensive roll-out of pick up and drop off points by competitors was primarily aimed at

improving their product offering and presence in the single piece parcels sector. It

argued that competitive constraints in the single piece parcels sector were causing it to

73 Parcel operators maintain outlets where consumers can drop off (and collect) parcels – in Royal Mail’s case this is the Post Office network. 74 Royal Mail does not pay VAT on universal service products, including First and Second Class services. 75 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI.

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be very cautious about the impact of price increases and materially constrained its

pricing behaviour.

b) It argued that consumers were increasingly aware of alternatives and use of

marketplaces and price comparison websites had increased competition.

c) It argued that “gig economy” labour models gave some competitors cost advantages

and distorted prices.

3.61 Hermes agreed that Royal Mail had a significant degree of pricing power, due to its

significant share of the parcels market, strong brand awareness and exclusive relationship

with the Post Office. However, Hermes argued that increased consumer choice of

providers plus general requirements on Royal Mail to provide parcel services at an

“affordable price” meant that adequate protection was in place for consumers and

including parcels in the cap was unnecessary. Hermes also argued that the risk of

reputational damage or of losing market share to competitors acted to constrain Royal

Mail’s pricing of parcels.

3.62 We set out our assessment of competitive constraints in parcels below, taking into account

stakeholder responses.

Our assessment

Context

3.63 Parcel products vary by weight and size (dimensions). The safeguard cap applies to Royal

Mail’s Second Class stamps for small and medium76 parcels weighing up to 2kg. Within the

single piece parcels sector, there are two main Royal Mail products which are available to

consumers for domestic services: First and Second Class universal services. Businesses are

likely to have access to a wider range of products including meter mail (which is also within

the scope of the USO but outside the scope of the safeguard caps) or bulk mail, subject to

meeting minimum volume thresholds. Figure 3.1 below summarises these products.

76 Maximum dimensions 45cm x 35cm x 16cm and 61cm x 46cm x 46cm respectively.

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Figure 3.1: Royal Mail parcel products by category (not to scale)

3.64 In line with our 2017 Review, we refer to single piece parcels as any parcel delivery service

which is available for purchase by any member of the public and can be used for sending

an individual parcel.77 We categorise any parcel product that does not fall within the scope

of that single piece description as a bulk parcel product. Bulk products are typically used by

businesses to deliver large volumes, and usually include negotiated volume discounts. Such

products are not generally available to consumers, given that few consumers are likely to

meet the minimum volume requirements which are pre-requisites to access these services,

and are therefore outside the scope of this review.

3.65 Single piece parcels can be sent from access points or collected from a sender’s premises.

We group both these types together in this analysis.

3.66 Overall, we estimate that single piece parcel volumes are increasing steadily, at around 2%

in 2017/18. We estimate that single piece parcels weighing 2kg or less increased by around

3%.78

3.67 Royal Mail has the largest share of all parcel volumes and revenues.79 However, unlike in

letters, competitors have a material presence in downstream delivery and provide

competing end-to-end services.

77 This is intended to include products that are sold through parcel reseller websites, such as Parcels2Go, as well as parcels services that are resold to users at a discounted price through marketplace websites, such as eBay. This definition excludes items sold on Amazon Marketplace that are delivered by Amazon Logistics. This is because Amazon Logistics delivery services are only available to those selling products through the Amazon website and are also required to be purchased in combination with other Amazon services (such as warehousing). 78 Ofcom calculation using parcel operator responses to s.55 Market Data Notices. 79 Including services offered through Royal Mail Group’s Parcelforce Worldwide arm. Ofcom calculation using parcel operator responses to s.55 Market Data Notices.

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3.68 Consumers sending single piece parcels with Royal Mail can either take the item to a Post

Office or place it in a pillar box – if the item is small enough and they have applied the

correct postage. Royal Mail also offers click and collect services via the Post Office and

increasingly via other Royal Mail customer service points such as Delivery Offices.

Parcelforce offers a premises collection service as well as allowing customers to drop off

parcels via the Post Office.

3.69 Competing operators offer similar products to those within the scope of the safeguard cap,

but these may have some differences in delivery timescales, maximum dimensions or other

features. For example, most competing providers offer tracking as standard.

Supply-side constraints

3.70 Royal Mail retains a very high share of single piece parcels weighing 2kg or below. We

estimate this was between 80-90% of both volumes and revenues ([]) in 2017/18. Royal

Mail also has a high share of single piece parcels as a whole, which we estimate was

between 70-80% of volumes and revenues ([]) in 2017/18.80 These shares have remained

broadly constant over the past two years.

Figure 3.2: 2017/18 volume shares of single piece domestic parcels <2kg

[]

Source: Ofcom calculation using parcel operator responses to s.55 Market Data Notices.

Figure 3.3: 2017/18 revenue shares of single piece domestic parcels <2kg

[]

Source: Ofcom calculation using parcel operator responses to s.55 Market Data Notices.

3.71 Our market research data aligns with these estimates – reported use of Royal Mail for

parcels is significantly greater than that of any competitors. In our recent Residential

Omnibus Survey, we asked residential consumers which companies they had ever used to

send a parcel. Of those that were regular parcel senders (which we measure as those that

had sent any small or medium parcels up to 2kg in the past month) 89% said they had used

Royal Mail to send a parcel at some point. The next most cited competing postal operators

were Hermes (37%) and Yodel (25%).81 Of respondents to our Residential Postal Tracker

who had sent parcels in the previous month, 92% had used Royal Mail at some point in the

past month. Hermes, the next most named competitor to Royal Mail, had been used by

just 15% of respondents in the past month.82

80 Ofcom calculation using parcel operator responses to the s.55 Market Data Notices – these shares are higher than reported in our 2017 Statement, as, in the s.55 Market Data Notices some providers have reclassified volumes, previously reported as single piece, as bulk. We lack data to make reliable comparison with earlier years, though we note Royal Mail has generally retained a significant majority of estimated volumes in this segment in previous years (for example, see 2017 Statement, paragraph 3.145). 81 Residential Omnibus Survey, Q14A. 82 Residential Postal Tracker, QD5.

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3.72 Competing operators have established their own networks of access points, often by

partnering with convenience stores and high street retailers to provide a drop-off service.

In many cases these networks also provide collection services for e-commerce deliveries.

Table 3.1 below summarises the main access point networks available for sending single

piece parcels.

Table 3.1: Access points

Parcel

operator

Number of access

points

Access points locations

Post Office Royal Mail / Parcelforce

11,500 Post Office branches/outlets

CollectPlus Yodel 7,000 Convenience stores (Paypoint

network)

MyHermes

ParcelShop

Hermes 4,500 Convenience stores

UPS Access Point UPS 2,800 Convenience stores

DPD Pickup DPD 2,500 Halfords, Pharmacy chains, Doddle

DHL Service Points DHL 1,200 Highstreet/retail park shops

InPost parcel

lockers

InPost 1,200 Convenience stores, petrol stations,

etc…

Parcelforce depots Parcelforce 54 Parcelforce depots

UK Mail (iPost

Parcels)

UK Mail 50 UK Mail depots

Source: Parcel operator websites (correct as of January 2019).

3.73 As noted in our 2017 Review, and mentioned by Royal Mail in its consultation response,

alternative access point networks have grown in recent years. In our view, this has been

largely driven by operators wishing to expand their pick up and drop off networks to

increase first time delivery success rates. Royal Mail argued this has been primarily aimed

at improving competitors’ product offering and presence in the single piece parcels sector.

3.74 However, as highlighted by consumer groups83 in their consultation responses, these

alternative networks tend to have lower coverage in rural areas compared to urban areas,

83 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI.

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meaning that the Post Office (and therefore Royal Mail84) is likely to still be the primary

option available to consumers in many rural areas, and these customers may find it difficult

to access services from alternative providers. Third party reports provided by Royal Mail

show that the Post Office has a smaller share of outlets in more densely populated areas

(such as London), and a greater share in less densely populated areas (such as Scotland,

Wales and the South West).85 However, we do not think that this difference in the

availability of alternatives would be likely to lead to a worse outcome for consumers in

rural areas. Royal Mail is obliged to offer a geographically uniform price for products falling

within the universal service. Where competition is present, even where it is largely limited

to urban areas, it will tend to constrain Royal Mail’s prices to some extent, which has the

potential to benefit all consumers regardless of location.

3.75 In addition, using alternative providers’ services often requires customers to access the

internet to pay for postage and generate a label. This is not the case for parcels sent via the

Post Office.

3.76 Most alternative providers are focused on bulk services (for example, delivering online

retail orders) or heavier weight single piece parcels. As demonstrated by the volume and

revenue shares above, there is currently limited competition for Royal Mail in single piece

parcels up to 2kg. Approaches to pricing suggest only a limited number of operators seek

to compete with Royal Mail for parcels weighing up to 2kg, though some of the higher

priced operators offer an enhanced service to Royal Mail’s Second Class products, such as

providing faster delivery or courier pick up.

Table 3.2: Competitor products and pricing

0-1kg 1-2kg

Royal Mail Second Class Stamp £2.95 (small);

£5.05 (medium)

£2.95 (small);

£5.05 (medium)

Hermes parcel shop drop off

(up to equivalent of Royal Mail medium parcel size)

£2.79 £3.99

Yodel/Collect+ drop off

(up to equivalent of Royal Mail medium parcel size)

£3.99 £3.99

UK Mail/ipostparcels (depot drop off) £5.09 (small);

£6.29 (medium)

£5.09 (small);

£6.29 (medium)

APC (courier pick-up) £13.80 £13.80

84 Royal Mail and Post Office have an exclusivity agreement that is due to run until 2022, whereby Post Office is Royal Mail’s exclusive retail outlet. 85 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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0-1kg 1-2kg

DPD local £7.19 £7.19

Yodel (doorstep collection) £7.19 (small);

£9.59 (medium)

£7.19 (small);

£9.59 (medium)

Source: Parcel operator websites (correct as of January 2019), inclusive of VAT where applicable. Where

options for delivery timescales offered, prices shown reflect closest comparison to Royal Mail’s Second Class

service.

3.77 Though alternative operators currently have a limited presence in lightweight single piece

services, there remains potential for other operators to expand into this area, especially if

they have already established access point and delivery networks for bulk fulfilment or

click and collect services. Royal Mail’s consultation response notes that investment in new

facilities (such as sorting centres) by competitors has generated c.25% ongoing annualised

spare capacity in the sector. It argues this has placed - and continues to place - downward

pressure on its prices. This excess capacity could potentially lower the cost of expansion for

competitors. However, we have seen limited expansion to date in lightweight single piece

parcels. As highlighted in our 2017 Statement, other carriers saw a rapid increase in single

piece volumes between 2013 and 201586, but since then their rate of growth has slowed, as

demonstrated by Royal Mail’s consistently high share of volumes and revenues.

3.78 Royal Mail and alternative providers are likely to have a variety of differing cost advantages

and disadvantages. Royal Mail has a substantial advantage over alternative providers due

to its established foot delivery network. This provides it with a cost advantage, particularly

for small and lightweight parcels which can fit through a letter box, as these can easily

share the letter delivery network (small and lightweight parcels are a sub-set of services in

the safeguard cap). This means some of the fixed costs of delivering such parcels are

shared with letter products. Further, Royal Mail’s universal services are exempt from VAT,

whereas competitors’ parcel services are not. []87. Conversely, in its consultation

response, Royal Mail argues that some competitors gain cost advantages through “gig

economy” labour models. Taken together, we do not consider that competitors have

overall cost advantages that would lead to a material increase in the competitive

constraints they can place on Royal Mail.

3.79 In summary, whilst competing operators are able to offer equivalent services to Royal

Mail’s Second Class stamp small and medium parcels, these operators have had limited

success to date in terms of gaining a significant share of the services covered by the

safeguard cap. They would have to overcome Royal Mail’s cost and VAT advantages in

lightweight parcels in order to do so. We consider that, given Royal Mail’s share of the

sector, supply-side constraints are unlikely to prevent Royal Mail from raising prices.

86 2017 Statement, paragraph 3.129. 87 [].

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Demand-side constraints

3.80 A consumer or business considering sending a single piece parcel (weighing up to 2kg) with

Royal Mail’s Second Class stamp products has, in theory, the following main alternative

options:

• sending the item using Royal Mail’s First Class stamp product;

• sending the item using a different Royal Mail payment method (e.g. meter);

• sending the item using a competing parcel operator; and/or

• not sending the item in the mail (potentially due to electronically transferring content

instead).

Alternative parcel products offered by Royal Mail

3.81 Royal Mail maintains differentials between its Second Class parcel stamp prices and its

other products to manage switching between products. For parcels, this also includes

differentials between weight steps and format sizes. As for letters, whilst this may

constrain standalone price increases in individual Second Class stamp prices, it would not

constrain a general increase in prices across products.

3.82 Whilst meter products can be used for parcels, in practice users of meter services are

primarily senders of letters rather than parcels. Just 2% of Royal Mail’s total Second Class

meter volumes were parcels in 2017/18.88 Royal Mail’s internal documents show that it

considers that parcels are posted via a meter for convenience, and thus are relatively

inelastic, though may still be targeted by competitors.89 Royal Mail’s modelling of switching

between products also illustrates that a proportion of stamp volumes would be expected

to switch to meter products in response to a moderate price increase, though in our view

this proportion is small.90

Send using competing parcel operator

3.83 As discussed above, competing operators account for a relatively small proportion of the

single piece parcels sector up to 2kg by both volume and revenue. Whilst many do offer

these products, few are price competitive with Royal Mail’s Second Class products. Royal

Mail’s consultation response also highlighted that some consumers are using marketplaces

to obtain better deals, such as buying postage through eBay’s own online channel. It also

mentioned the growing use of price comparison websites facilitating consumer choice

between alternatives. Hermes argued that the risk of losing market share to competitors

acts to constrain Royal Mail’s pricing of parcels.

3.84 The threat of consumer switching to competing providers with similar tariffs may constrain

Royal Mail’s pricing to some degree. To the extent that marketplaces or price comparison

websites facilitate this, the strength of this constraint may have increased to some degree.

88 Royal Mail Regulatory Financial Reporting Information. 89 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 90 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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Royal Mail’s internal documents indicate that it considers rivals’ pricing when setting its

own prices, and is concerned about the prospect of entry and expansion of competitors in

the single piece parcel sector. Royal Mail considers that overcapacity in the market

increases the risk of losing volume to competitors.

3.85 However, Royal Mail has significant brand advantages over its near-competitors in single

piece lightweight parcels. Our Residential Omnibus Survey indicates that 95% of

respondents were aware of Royal Mail, but just 61% were aware of Hermes.91 There is a

similar picture amongst businesses, with 80% naming Royal Mail when asked to think of

postal providers, compared to 12% naming Hermes.92 Royal Mail’s own consumer research

also shows this advantage in brand strength. Consumers are significantly more aware of

Royal Mail, more likely to consider using Royal Mail and more likely to actually use Royal

Mail.93 In its consultation response, Royal Mail notes that awareness of competitors had

increased in recent years, and that marketplace sellers in particular are more aware of

competitors. However, this does not change our view that Royal Mail enjoys an advantage

in consumer awareness relative to its competitors, including amongst marketplace sellers,

even if this advantage may be smaller than in the past.

Price sensitivity

3.86 Our consumer research suggests that price responsiveness is relatively low in parcels. 9%

of residential consumers indicated they would send fewer parcels in response to a 10%

price increase, and 3% indicated they would not send any parcels. Just 10% said they would

send fewer, and 4% said they would not send any, in response to a 20% price increase.94

Among business users, just 3% said they would send fewer parcels in response to a 10%

price increase. In response to a 20% price increase, just 4% said would send fewer parcels

and 1% indicated they would not send any.95

3.87 As for letters, we treat this evidence from market research with a degree of caution, given

that survey responses to hypothetical questions have a tendency to overstate actual price

responsiveness. In addition, our research does not provide an indication of the extent of

volume response envisaged by those who would send fewer parcels.

3.88 Royal Mail’s own elasticity estimates suggest similar or less price responsiveness at a

market level. It estimates that demand for small and medium parcels is relatively inelastic

(estimated as []).96

3.89 This suggests that the risk is low that consumers would respond to a price increase for

parcels by choosing not to send the parcel (except perhaps in certain circumstances where

digital alternatives are available such as electronically transferring content as opposed to

91 Residential Omnibus Survey, Q13 – prompted. This aligns closely with our Residential Postal Tracker, QI1, which shows 96% of consumers are aware of Royal Mail and 73% aware of Hermes. 92 Business Postal Tracker, 2018, QV3 – unprompted. 93 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 94 Residential Omnibus Survey, Q11 and Q12. 95 Business Postal Tracker, 2018, QN7c and QN7d. 96 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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sharing content via a physical CD or DVD transmissible by post). Accordingly, we consider

that this is not likely to provide a strong constraint on Royal Mail’s pricing.

Pricing behaviour for large letters and parcels

3.90 As we regulate large letter and small and medium parcel prices as part of the same basket

cap, we consider Royal Mail’s pricing behaviour for these products together in this sub-

section.

Our consultation proposal

3.91 In our July 2018 Consultation, we proposed that uncertainty around potential market

responses to further significant pricing changes, and the risk of unforeseen responses to its

pricing strategy may constrain Royal Mail’s pricing decisions and discourage it from making

radical changes to pricing. However, we did not think that it was clear this risk would

constrain more moderate price increases, particularly given the limited price competition

that Royal Mail currently faces.

Stakeholder responses

3.92 Royal Mail noted its moderate price increases for letters (including large letters) in recent

years, arguing these reflected constraints on its pricing due to risks from e-substitution,

‘tipping points’ or competition. It also argued that its internal pricing decision papers

showed concern with the risks of losing volume to competitors if it increased parcel prices.

It also noted the impact of its decision to introduce size-based pricing in 2013, subsequent

changes to win back volume and argued that since then competition had continued to

constrain its prices.

3.93 Hermes argued that the fact that Royal Mail is pricing significantly below the basket cap,

combined with the risk of reputational damage and loss of market share in single piece

parcels, meant that the cap, for parcels at least, was redundant. Hermes also notes that

Royal Mail’s pricing decisions allowed competitors (such as Hermes) to gain a foothold in

the single piece parcel market.

3.94 We set out our assessment of Royal Mail’s pricing behaviour for large letters and parcels

below, taking into account stakeholder responses.

Our assessment

3.95 Our 2012 Basket Cap Statement introduced a basket cap covering large letters and parcels,

at 53% above prevailing prices, with subsequent annual increases by CPI. For large letters,

Royal Mail’s pricing strategy was in line with its approach to standard letters, introducing

significant increases in 2012 and smaller regular increases in subsequent years. Although

large letter prices have increased substantially, they have remained below the maximum

that would be permitted under the basket safeguard cap.

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3.96 Royal Mail made changes to its products to introduce size-based pricing for parcels in 2013.

This increase in prices reduced the headroom under the basket cap to 10% in 2014/15.

These changes meant that some parcel prices effectively increased by more than 100%.

This allowed competitors, particularly Hermes, to gain a foothold in this market segment,

which resulted in a []% decline in single piece parcel volumes for Royal Mail.97 In

response, Royal Mail made some changes to its pricing structure which resulted in

reductions to some parcel prices, including the introduction of a flat 0-2kg rate for small

and medium parcels. It has since proceeded in a cautious manner raising prices by around

2% per annum in recent years. Royal Mail internal documents state that this has allowed it

to slow volume decline and return to growth in parcels.98 Royal Mail retains significant

headroom under the basket safeguard cap which it could use to increase parcel prices

significantly.

3.97 As argued by Royal Mail and Hermes, this may suggest that competitors could constrain

Royal Mail’s parcel pricing to some degree, but there is little evidence that competitor

responses have had a significant impact on Royal Mail, except in the case of very significant

price increases such as those that affected some shapes and weights when size-based

pricing was introduced in 2013. Whilst uncertainty around the prospect of entry and

expansion by competitors may lead Royal Mail to take a cautious approach to price

increases for parcels, there is little to suggest that moderate increases would be

unprofitable.

3.98 This uncertainty around potential market responses to further significant pricing changes,

and the risk of unforeseen responses to its pricing strategy may constrain Royal Mail’s

pricing decisions and discourage it from making radical changes to pricing. However, it is

not clear that this risk would constrain more moderate price increases, particularly given

the limited price competition that Royal Mail currently faces. Accordingly, we consider that

competitive constraints are not sufficiently strong to constrain prices in the absence of a

safeguard cap.

Conclusion on competitive constraints in large letters and parcels

3.99 For large letters services, Royal Mail remains a near-monopolist in the provision of these

services. Whilst the risk of accelerating e-substitution may cause Royal Mail to be cautious

in implementing significant price increases, there is limited evidence that e-substitution

represents a meaningful constraint on Royal Mail’s ability to profitably raise prices for

single piece large letters (particularly with respect to smaller price increases). We therefore

remain of the view expressed in our 2017 Review that Royal Mail faces only limited

competitive constraints on its prices for single piece large letters.

3.100 For parcels services, Royal Mail’s strong market position, widespread access network, VAT

exemption and strong brand recognition gives it a significant degree of pricing power for

Second Class parcels weighing up to 2kg. This is greater still for small and lightweight items

97 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 98 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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that can fit through a letter box, as Royal Mail has cost advantages for these items due to

its established integrated parcels and letters delivery network. We remain of the view that

we cannot rely on competitive constraints to prevent Royal Mail from raising prices for the

parcel products subject to the safeguard cap. Whilst Royal Mail is not currently pricing to

the cap, it has made use of a significant proportion of the headroom under the cap, and

has tended to increase prices steadily (roughly in line with RPI) in recent years.

3.101 Our assessment is that Royal Mail continues to have a significant degree of pricing power

in both single piece large letters and small and medium parcels up to 2kg. We consider

that, absent regulation, Royal Mail would be able to increase prices materially. However,

uncertainty about e-substitution (in letters) or competitor responses (in parcels) may act to

limit the scale of price increases implemented at one time.

Variation in competitive conditions within large letters and parcels

Our consultation proposal

3.102 In our July 2018 consultation, we considered that the evidence did not suggest sufficient

differences in competitive conditions such that a different approach to parcels and large

letters would be appropriate. We also considered that interactions between products were

not sufficiently strong that a control on some products would constrain the prices of other

products sufficiently such that they could be removed from the cap. Accordingly, we

proposed that both large letters and small and medium parcels up to 2kg should remain

within the same basket cap.

Stakeholder responses

3.103 Hermes argued that large letters and parcels should not be part of the same cap as the

prices competing parcel operators can charge to remain competitive with Royal Mail could

be artificially impacted by the price of large letters, where competition is more limited.

3.104 We set out our assessment of variations in competitive conditions within large letters and

parcels below, taking into account stakeholder responses.

Our assessment

3.105 To inform our decision on the scope of the basket, we have considered the extent to which

competitive conditions differ between products within the direct scope of the basket cap

(i.e. Second Class large letters and small and medium parcels up to 2kg).

3.106 Royal Mail faces some competition in small and medium parcels, but virtually no

competition in large letters. However, in both instances, Royal Mail remains by far the

largest operator with a significant degree of pricing power.

3.107 If competitive conditions differed materially, and the basket cap was currently ‘biting’ on

Royal Mail, retaining the products under the same basket cap could distort competition.

This is because it would give Royal Mail a strategic incentive to rebalance prices across the

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basket products to meet the basket cap constraint by setting higher prices in products

where it faces a limited threat of competition, and lower prices where it faces greater

competition. This could allow it to foreclose competition, whilst maximising revenues

within the constraint of the basket cap.

3.108 We agree with Hermes that there are some differences in competitive conditions between

large letters and single piece parcels. As discussed above, Royal Mail is a near-monopolist

in large letters but faces some competition in single piece parcels. However, the evidence

does not suggest sufficient differences in competitive conditions such that a different

approach to parcels and large letters would be appropriate. In both sectors, Royal Mail has

a very high share, substantial cost and scale advantages, and limited competitive

constraints on its pricing.

3.109 Further, Royal Mail continues to price significantly below the basket cap, meaning the cap

is not currently a determining factor in the structure of Royal Mail’s prices for products

within the basket cap. We recognise there is potential for some segments to experience a

growth in competition, such that it may be appropriate in the future to amend the scope of

the safeguard caps.

3.110 We have also considered whether interactions between products are sufficiently strong

that a control on some products, such as Second Class standard letters, would constrain

the prices of other products sufficiently such that these other products can be removed

from the cap. There are clear interactions between First and Second Class products and

payment types (e.g. stamp or meter) within sectors. Consumers trade off between

products based on their requirements and expected volumes. This is demonstrated by

Royal Mail’s attempts to broadly maintain consistent differentials and their considerations

when setting prices (based on its internal documents).99

3.111 However, given current differentials between standard letters and large letters and parcels

of different weights, it is unlikely that an increase in a smaller or lighter product would be

materially constrained by the risk of switching to a larger or heavier product. Current

significant differentials also mean that, if switching to a smaller or lighter product was

possible, consumers would likely already have done so. A moderate widening of the

differential would be unlikely to prompt significant additional switching. Accordingly, we

consider that a cap on both standard letters and large letters and parcels remains

necessary.

Our conclusions on the market analysis

3.112 Overall, we remain of the view set out in our 2017 Review that competitive constraints are

still insufficient to prevent Royal Mail from raising prices for the products under the

safeguard caps.

99 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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3.113 Royal Mail remains a near-monopolist in standard letters and large letters, with little threat

of entry. The risk of triggering a step-change in e-substitution may act to constrain very

substantial price increases, but is unlikely to provide protection against smaller increases.

3.114 Though there is more competition in the parcels sector, this is limited for small and

lightweight single piece items, where Royal Mail retains a very high share of volumes and

revenues. Past competitor responses to very large price increases may lead Royal Mail to

act cautiously, but this is unlikely to constrain Royal Mail from implementing moderate

price increases.

3.115 Finally, there is insufficient evidence of differences in competitive conditions to suggest

that a change in the structure or scope of the safeguard caps is necessary.

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4. Assessing affordability

Introduction and summary

As discussed in section 2, when setting tariffs, such as the safeguard caps, in relation to the

provision of the universal postal service, we are required under section 36(5) of the PSA

2011 to ensure that the prices of the relevant services are affordable, take account of the

costs of providing the service and provide incentives to provide the service efficiently.

Assessing affordability is therefore a very important component of our assessment of the

safeguard caps.

This section sets out our assessment of the extent to which consumers, especially

potentially vulnerable consumers, are likely to consider the safeguarded products to be

affordable both at current prices and at prices above the level of the caps.

In summary, in the July 2018 Consultation, we found that there is a range of evidence and

no single price point emerges as clearly being the limit of affordability. However,

determining the appropriate level of the safeguard caps requires us to identify a specific

limit. This requires regulatory judgment, balancing different evidence and the likely effects

on different groups of consumers. In the July 2018 Consultation, our judgment was that an

increase of 5% in real terms above the current level of both the letters and basket caps

would not render the letter products unaffordable for either consumers generally or a

significant majority of those we have identified as potentially vulnerable. The potential for

adverse effects on some vulnerable consumers and the evidence of changes since 2013

lead us to judge that a larger increase for either cap should be considered unaffordable.

Having considered consultation responses and updated our research, we remain of this

view.

This section summarises our consultation position and stakeholder responses, and sets out

our affordability analysis having taken responses into account.

Methodology for assessing affordability

Our consultation proposal

In the July 2018 Consultation, we set out our proposal to assess affordability using the

same approach as we used in The Affordability of Universal Postal Services100 (the “2013

Report”). This report included our findings with respect to better understanding

consumers’ use of and needs for post and how we intended to monitor the affordability of

universal postal services on an ongoing basis.

100 Ofcom, 2013. The Affordability of Universal Postal Services.

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Stakeholder responses

Royal Mail considered that “Ofcom should not simply assume the findings from [the 2013

Report] still hold today”. It stated that we should consider up-to-date research to ascertain

whether prices above 65p would be unaffordable.101 As such, Royal Mail stated that our

conclusion that a larger increase [than 65p] should be considered unaffordable is not

supported by evidence, and that prices would remain affordable if the cap was set above

65p.102

We received no other stakeholder comments on our approach to assessing affordability.

Our assessment

We have decided to maintain the approach to assessing affordability that we used in the

2013 Report for the purposes of this decision, whilst using the most recently available

research (e.g. our 2018 Residential Postal tracker) to inform our decision. We have

adopted this methodology, whilst noting that no one approach can be definitive about

whether the price of a good or service may be considered unaffordable.

Following the approach set out in the 2013 Report, we have identified two ways in which

postal services might be considered unaffordable for residential consumers, namely where:

• consumers reduce their purchases of postal services due to the price; and/or

• consumers continue to buy postal services, but have to cut back on other essential

expenditure.

We have focused our analysis on certain consumer groups of interest,103 as follows:

• those with low income;

• those living in rural areas (as they may have a higher reliance on post); and

• other consumers who may be particularly reliant on postal services. For example, those

who are aged over 65, or who have a disability, or who have no or limited access to the

internet104, or recent immigrants to the UK.

We have focused on these groups because we maintain the view that certain consumer

groups may be particularly vulnerable with respect to sending post, either because they

have a particularly high need to send universal service post products, and/or because they

lack the means to do so. We also consider that, if the evidence suggests that vulnerable

consumers in general would be able to afford universal postal services, we can be

confident that all consumers on average would be able to afford universal postal services.

101 Royal Mail’s non-confidential response to Ofcom’s July 2018 Consultation (“Royal Mail’s non-confidential response”), paragraph 2.10. 102 Royal Mail’s non-confidential response, page 13. 103 We identified the same potentially vulnerable consumer groups in the 2013 Report, paragraph 3.23. We also note that there is a significant degree of overlap between some of these groups. 104 ‘No internet’ means consumers that have no broadband access at home.

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For SMEs, we find that postal services may be unaffordable for a business only where the

following three conditions are met:

• universal postal services are a critical input to the business’ commercial proposition;

• there is a lack of good alternatives to universal postal services available to the

business; and

• the cost of universal postal services is important for the business’ financial position.

In order to assess whether these conditions are met, we collected data from our Business

Postal Tracker on postal expenditure and sending patterns. Our general approach to

assessing affordability for SMEs remains to identify businesses which are potentially (but

not necessarily) at risk of finding Second Class postal services unaffordable and to consider

the extent to which the prices of universal service postal products might materially harm a

business’ commercial position.

This approach to assessing affordability, for both residential consumers and SMEs, is

designed to take account of the way in which these consumers use universal postal

services, as well as how the affordability of universal postal services has previously been

assessed. Furthermore, the assessment is informed by approaches to assessing

affordability in other sectors, as well as the way in which regulatory authorities in EU

Member States have assessed whether universal postal services are affordable. We

consider that such an approach is appropriate for the purposes for our assessment of

affordability.

As noted above, Royal Mail expressed concern that, in following this methodology, we had

assumed that findings from our 2013 affordability analysis, uplifted by 5%, still held today.

Whilst the methodology we used in 2013 has remained the same, our analysis and thus our

assessment itself has been updated to take in to account the most recently available

sources of data. We have collected the following data relating to residential consumers

(and in particular those belonging to potentially vulnerable groups105):

• data from our Residential Omnibus Survey on consumers’ postal expenditure and

sending patterns, broken down by consumer type;

• data from our Residential Postal Tracker on consumers’ postal expenditure, sending

patterns and; and

• data on household expenditure and disposable incomes from ONS Living Costs and

Foods Survey106, broken down by consumer type and over time.

Comparisons with the 2013 Report, which we believe represented an accurate analysis of

affordability at that time, provide us with further useful information. As an example, when

considering real household disposable income as a measure for affordability, we can

understand the context of how this has changed over time, and what this means for the

current level of affordability. We believe that such an approach to measuring affordability

105 For the purposes of this assessment we categorise consumers in the following groups as potentially vulnerable, consumers: (i) over 65; (ii) without internet access; (iii) rural areas; and (iv) in socio-economic group C2DE. 106 Data taken from ONS, 2018. Living Costs and Food Survey.

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remains appropriate for the purposes of this review, although we note that defining a

precise point at which the Second Class products may become unaffordable is challenging.

The 2013 Report considered the affordability of all universal postal services. Our decision in

this statement is, however, focused particularly on the affordability of the Second Class

products subject to the safeguard caps. Where possible, we have sought to focus our

consumer research and data collection on the Second Class products. To the extent that

our research relates to the affordability of the universal postal services more broadly, this

is highlighted below. However, we consider that the more general considerations of the

affordability of universal services also apply to the affordability of the specific Second Class

products subject to the safeguard caps.

For SMEs, we have collected data from our Business Postal Tracker on postal expenditure

and sending patterns. Our general approach to assessing affordability for SMEs remains to

identify businesses which are potentially (but not necessarily) at risk of finding Second

Class postal services unaffordable.

Affordability for residential consumers

Our consultation proposal

Assessing affordability for residential consumers requires weighing up a range of evidence.

In order to do this, we have split our analysis into three parts:

• use and expenditure for postal services;

• disposable income and comparator spending; and

• market research on affordability.

In the July 2018 Consultation, we found that post makes up a small proportion of total

expenditure, and in absolute terms, only amounts to approximately 70p a week.

We also found that, compared to 2012/13, real disposable incomes have risen across all

households, although for low-income retired households this growth has been moderate,

and expenditure on comparable communications services has increased by more in

absolute terms than it has for post.

Finally, when considering the interaction between spending on post and spending on other

essentials, we found that post remains affordable for most consumer groups. However, we

did recognise that unfortunately some consumers who suffer significant financial difficulty

and have a frequent need to send post may find Second Class postal services unaffordable,

even at a significantly reduced price.

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Stakeholder responses

Both Citizens Advice107 and CAS108 agreed that it is challenging to identify a single price

point as the limit of affordability, with CAS also adding that any such decision requires a

degree of regulatory judgment.

Citizens Advice considered that our “analysis of affordability is reasonable given relatively

low household spend on post”. Nonetheless, it also stated that letters remain “essential for

vulnerable consumers who are less able to switch to digital alternatives, and it is vital that

they remain affordable to all consumers”.109

Citizens Advice also noted an “increase in private rental costs over the last few decades,

with low income consumers most impacted”, and suggested that “[i]ncluding income ‘after

housing costs’ in any assessment of affordability may be valuable”.

Whistl stated it had “every reason to believe and support the analysis that Ofcom

produced on expenditure on services and affordability for vulnerable groups”110, whilst

MCF did not challenge our affordability analysis. 111

The CCNI carried out its own research which considered the affordability of Second Class

postal services in Northern Ireland.112 It found that the proposed level of the cap may

present affordability issues for vulnerable consumers, particularly those without access to

the internet and those with a disability.

Royal Mail stated that we had “failed to test specific prices with the core demographic -

vulnerable consumers”.113

Royal Mail interpreted the results of our research into consumers’ responsiveness to

hypothetical 10% and 20% price increases in our market analysis114 as consumers finding

prices affordable. Specifically, it stated “the limited change in consumer behaviour is a

result of the prices being affordable and remaining so, even if prices were higher”.115

Royal Mail also commented on the results of our Residential Postal Tracker which

suggested that consumers see stamps as representing good value for money and

107 Citizens Advice non-confidential response to Ofcom’s July 2018 Consultation, page 4. Citizen’s Advice also submitted that we should take further measures to address affordability concerns, such as introducing a discount scheme. We consider that setting the caps as described in this statement sufficiently addresses affordability concerns based on our current assessment. 108 CAS’ non-confidential response to Ofcom’s July 2018 Consultation, page 2. 109 On 18 October 2018 Ofcom presented the proposals set out in the July 2018 Consultation to the Communications Consumer Panel (“CCP”). The CCP were concerned that the safeguard caps should remain at an affordable level for consumers who rely on postal services, and noted that Ofcom had undertaken robust research to determine whether the safeguarded products were affordable for residential consumers (particularly vulnerable consumers) and small businesses. 110 Whistl’s non-confidential response to Ofcom’s July 2018 Consultation, page 1. 111 MCF’s non-confidential response to Ofcom’s July 2018 Consultation, pages 1-2. 112 CCNI’s non-confidential response to Ofcom’s July 2018 Consultation (“CCNI’s non-confidential response”), pages 17-32. 113 Royal Mail’s non-confidential response, page 13. 114 See paragraph 3.38 115 Royal Mail’s non-confidential response, paragraph 2.11.

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consumers are generally satisfied with features of Royal Mail’s service.116 Royal Mail

claimed its own consumer research supported this view, as indicated by year-on-year

increases in its net promoter score117 and consumers reporting a high satisfaction rate with

regard to their sending and receiving experience with Royal Mail.118

Our assessment

Since the July 2018 Consultation, we have published the results of our most recent

Residential and Business Postal Trackers in August 2018 and have thus updated our

analysis where relevant.

Use and expenditure for postal services

Information on usage of postal services comes from our Residential Postal Tracker,

Residential Omnibus Survey and the ONS Living Costs and Food Survey.

Our Residential Omnibus Survey suggests that on average consumers sent 2.3 letters or

small and medium parcels in the past month, around two-thirds of which are standard

letters, but a majority of respondents said they sent no post in the last month.119

Our Residential Postal Tracker suggests a slight increase in the volume of post sent from

2012/13 to 2017/18, from around 7 to around 8 items of post per month on average.120 A

like-for-like comparison, taking into account a change in methodology in our tracker121,

suggests a small decrease, with an average of 6 items sent per month in 2017/18. 18% of

respondents said they had not sent any post in the last month in 2012, compared to 15% in

2017/18.122 Research carried out by CAS indicates that only 43% of consumers in Scotland

send personal letters at least once a month.123 This is broadly in line with our finding that

residential consumer usage of the postal service is relatively low.

116 Royal Mail’s non-confidential, paragraph 2.6 to 2.8. 117 The net promoter score is an index ranging from -100 to 100 that measures the willingness of customers to recommend a company’s products or services to others. It is used as a proxy for gauging the customer’s overall satisfaction with a company’s product. 118 Royal Mail’s non-confidential response, paragraph 2.6 to 2.9. 119 Residential Omnibus Survey, Q2 – data from April 2018 fieldwork. As postal use is seasonal this represents a non-peak month rather than an average across the year. 120 Residential Postal Tracker, QD1. 121 In 2012/13, tracker data was collected exclusively using face-to-face interviews. We now collect data using a mix of online and face-to-face surveys which is then weighted to the overall UK population. This like-for-like comparison uses only the data collected via face-to-face interviews. Our Residential Postal Tracker appears to show greater levels of usage in 2017 than our Residential Omnibus Survey. The questions on usage in each survey are not directly comparable. Our Residential Omnibus Survey asks simply about use of standard letters, large letters and small and medium parcels. Our Residential Postal Tracker asks about specific items of post (such as postcards or greetings cards), so is likely to generate a different response. 122 Residential Postal Tracker, QD1. 123 CAS Consumer Tracker Survey: Wave 2, unpublished, page 28.

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In general, consumer spending on post is also low. ONS data shows on average households

spent 70p per week on postal services in 2016/17.124 This data covers all postal services and

is similar in real terms to expenditure in 2012/13.

Our Residential Omnibus Survey aligns with ONS estimates, and indicates that the sum of

average spending on each of standard letters, large letters and small and medium parcels

(up to 2kg) was around £3.10 in the last month (or approximately 70p per week).125 This

estimate (and ONS data) also includes First Class mail and other products, so actual

expenditure on Second Class services will be lower than these estimates.

There are significant differences in usage and spending by consumer group, as illustrated in

Figures 4.1 and 4.2 below. In relation to those consumer groups which are likely to

comprise vulnerable consumers, we observe the following126:

• Consumers aged over 65 and consumers without internet access both send more mail

items than average, and a greater proportion of these items are standard letters. As a

result of their reliance on cheaper, more basic postal services, total spending for these

customer groups is below average.

• Consumers living in rural areas send slightly more mail items, and report slightly higher

average spending.

• Consumers in socio economic groups C2DE send fewer items than average, and spend

less on postal services than average.

Some of these trends are in line with our 2013 Report findings, particularly that older

consumers tend to send more postal items and lower income consumers tend to send less

than average, although we note that research carried out by the CCNI indicates that, for

consumers in Northern Ireland, usage is slightly higher than average for those who live in

rural areas or those with a disability.127

124 Data taken from Living Costs and Food Survey, table 3.2E: ‘Detailed household expenditure as a percentage of total expenditure by equivalised disposable income decile group (OECD-modified scale), UK.’ https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/expenditure/datasets/detailedhouseholdexpenditureasapercentageoftotalexpenditurebyequivaliseddisposableincomedecilegroupoecdmodifiedscaleuk32e. 125 Residential Omnibus Survey, Q1 – includes those that spent nothing on post. 126 Residential Omnibus Survey, Q1 – includes those that spent nothing on post. 127 CCNI’s non-confidential response, page 22.

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Figure 4.1: Average items sent per month, by customer group

Source: Residential Omnibus Survey, Question 2.

Figure 4.2: Average monthly spend on post (£), by customer group

Source: Residential Omnibus Survey, Question 1.

Use of postal services is seasonal for many consumers, with a significant increase in

average use and spending over the Christmas period. For many consumers, there are peaks

in postal spending, which could make issues of affordability more acute at these times. For

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example, on average, consumers surveyed in January 2018 reported spending £13.16 in

the last month, compared to an annual average of £9.45 per month in 2017/18.128

ONS data on household expenditure129 (as shown in Figures 4.3 and 4.4) indicates that

expenditure on post for all households and low income households has remained small and

largely constant since 2012/13, in both level and share of total expenditure. Spending by

consumers aged 65 or over is higher than average and appears to have increased in

2016/17.130 However, it remains a small share of total expenditure.

128 Residential Postal Tracker, QD4. Any responses that stated “I prefer not to say” or “I don’t know” were excluded from the calculations of the mean average and the January spend figure. 129 Data taken from Living Costs and Food Survey, table 3.2E: ‘Detailed household expenditure as a percentage of total expenditure by equivalised disposable income decile group (OECD-modified scale), UK.’ 130 Data taken from Living Costs and Food Survey, table A11: ‘Detailed household expenditure by age of household reference person, UK.’ https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/expenditure/datasets/detailedhouseholdexpenditurebyageofhouseholdreferencepersonuktablea11.

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Figures 4.3 and 4.4: Household expenditure on post, level (£/week) and share of total expenditure,

by customer group, 2012/13 to 2016/17

Source: Ofcom calculations using ONS Living Costs and Food Survey, 2016/17 prices, adjusted using CPI.

In general, this evidence indicates that post continues to make up a small share of

household expenditure, and that little has changed since 2012/13. There is some indication

that some potentially vulnerable consumers may send more items or spend more on postal

services than was the case in 2012/13, but overall expenditure by these groups remains

broadly in line with 2012/13 levels.

Disposable income and comparator spending

Assessing changes in household incomes and expenditure since 2012/13 and considering

trends in expenditure on comparator products, provides us with an indication of the

resources available to households and whether spending on post might be constrained.

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Our calculations, from ONS data131, summarised in Table 4.1 suggest that real disposable

incomes have increased by 8.9% across all households over the period 2012/13 to 2016/17.

Real disposable incomes have increased for average retired households at a faster rate

than non-retired households. When looking at lower income consumers, who may be more

likely to be vulnerable, real disposable incomes have increased by 7.6% for the bottom

decile and 9.5% for the bottom quintile. Low income retired households have experienced

a slower growth in disposable incomes; 1.9% for the bottom decile and 3.0% for the

bottom quintile.

Table 4.1: Cumulative growth in real disposable incomes by group, 2012/13 to 2016/17

Bottom decile Bottom quintile All incomes

All households 7.6% 9.5% 8.9%

Non-retired households 11.9% 12.9% 8.4%

Retired households 1.9% 3.0% 10.6%

Source: Ofcom calculations from ONS Living Costs and Food Survey. We use equivalised household incomes to

control for the effect of changes in household size. 2016/17 prices, adjusted using CPI.

Citizens Advice noted that considering income after housing costs may be useful in our

assessment of affordability. As the Living Costs and Food Survey does not provide any

information on this metric, we have used data from the Households Below Average Income

Report (HBAI) to assess this.132 The data indicates that real disposable income after housing

costs has decreased by 3.7% since 2012/13 for the bottom decile. However, the ON notes

that this result must be treated with a degree of caution as small changes in estimates

from year-to-year, particularly at the bottom of the income distribution may not be

significant in view of data uncertainties. For the bottom quintile, income has grown by

6.8%, whilst across all households income has increased by 7.3%.

Using the same HBAI dataset, we have also assessed regional trends of growth in real

disposable incomes for all households before and after housing costs.133 The results,

summarised in Table 4.2 indicate that, whilst there is some regional variation, on average

real incomes have risen for consumers across the country. This dataset does not provide

131 Data taken from Living Costs and Food Survey, tables 2, 2a, 3, 3a, 4 and 4a: ‘Effects of taxes and benefits on household income.’ https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/datasets/theeffectsoftaxesandbenefitsonhouseholdincomefinancialyearending2014. 132 Data taken from Households Below Average Income Report, table 2_1ts. Equivalised household incomes are used to control for the effect of changes in household size. 2016/17 prices. https://www.gov.uk/government/statistics/hbai-199495-to-201617-incomes-data-tables 133 Data taken from Households Below Average Income Report, tables 2_5ts. The dataset reports incomes as three year averages, so we have calculated the median income growth rates between 2012/13 – 2014/15 to 2014/15 – 2016/17. Equivalised household income is used to control for the effects of changes in household size.

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more granular information for the consumer groups which we identified as being

potentially vulnerable, but we nevertheless consider the overall regional averages to be

useful for this assessment.

Table 4.2 Growth in real disposable incomes for all households by region, 2012/13 – 2014/15 to

2014/15 – 2016/17

Before housing costs After housing costs

England 4.5% 5.0%

North East 5.9% 7.5%

North West 3.0% 2.9%

Yorkshire and the

Humber

4.6% 5.3%

East Midlands 3.6% 6.5%

West Midlands 5.9% 7.7%

East of England 3.8% 3.7%

London 4.3% 5.1%

South East 2.1% 2.6%

South West 4.0% 6.3%

Wales 3.0% 2.9%

Scotland 3.0% 3.6%

Northern Ireland 5.3% 5.6%

ONS data134 also shows that total household expenditure has increased by 2.4% over the

same 2012/13 to 2016/17 period, by 2.2% for the bottom income decile and by 2.5% for

households where the reference person is aged 65 or over.

Overall household expenditure and expenditure on comparable communications services

(namely, telephone services) has increased by more in absolute terms than spending on

134 Data taken from Living Costs and Food Survey, table 3.2E: ‘Detailed household expenditure as a percentage of total expenditure by equivalised disposable income decile group (OECD-modified scale), UK’ and table A11: ‘Detailed household expenditure by age of household reference person, UK’.

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post. This holds for both all households and the bottom income decile. This is summarised

in Table 4.3 below.

Table 4.3: Absolute change in real household expenditure, £/week, 2012/13 to 2016/17

All households Bottom decile Aged 65 and over

Expenditure on post +0.1 0.0 +0.3

Expenditure on telephone services +1.1 +1.1 +1.2

Total expenditure +12.9 +5.7 +9.9

Source: Ofcom calculations from ONS Living Costs and Food Survey, 2016/17 prices, adjusted using CPI.

Taken together, this evidence indicates that households (including potentially vulnerable

households) have allocated increased income and expenditure to items other than post.

This suggests that spending on postal services was not, and has not become, constrained

by income for most households. The increase in household incomes and total expenditure,

including for the lowest income decile, since our 2013 Report may suggest that the

affordable level of prices for postal services has increased in line with this.

Market research on affordability

Our 2017/18 Residential Postal Tracker data shows 8% of respondents reported reducing

use of post to afford essentials, and 4% had to cut back on essentials to afford post.135 This

proportion does not appear to be significantly greater for potentially vulnerable consumer

groups. The equivalent figures for 2012/13 were 3% and 2% respectively136, however we

hypothesise this may be due to a change in methodology.137 A like-for-like comparison,

taking into account this change in methodology gives figures of 2% and 1% for 2017/18,

may suggest little actual change once the effect of the change in methodology is removed.

Royal Mail argued that we had failed to test specific prices with the core demographic –

vulnerable consumers. Whilst we have not tested specific prices with consumers due to the

difficulty in drawing strong conclusions from hypothetical questions, we have considered

the core demographic through various data splits which cover key metrics of affordability

for vulnerable groups.

135 Residential Postal Tracker, QF1. 136 Residential Postal Tracker 2012/13 (Q3, 2012: https://www.ofcom.org.uk/__data/assets/pdf_file/0008/51011/q32012-tracker-data.pdf); (Q4, 2012: https://www.ofcom.org.uk/__data/assets/pdf_file/0008/51200/q42012-trackerdata.pdf); Q1, 2013: https://www.ofcom.org.uk/__data/assets/pdf_file/0014/41072/trackerq12013.pdf); (Q2, 2013: https://www.ofcom.org.uk/__data/assets/pdf_file/0017/41732/trackerq22013.pdf). 137 See footnote 121 above.

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For low income consumers, with annual household income below £11,500, 14% reported

reducing use of post to afford essentials, and 7% had to cut back on essentials to afford

post in 2017/18.138 There is little difference between older consumers and the general

population. This suggests that, for some potentially vulnerable groups, there is an

increased risk of affordability issues compared to the general population.

Our consumer research does not appear to suggest a significant variation in affordability

across nations and regions. We note that CCNI has carried out research on potentially

vulnerable consumers in Northern Ireland.139 This research indicates that, on average, at

63p and 67p respectively, consumers with a disability and consumers without access to the

internet would find Second Class standard letters unaffordable. Broadly speaking, this

research supports our view that a small increase in real terms above the current level of

the caps would not render Second Class products unaffordable for either consumers

generally or a significant majority of vulnerable consumers, but that a larger increase

should be considered unaffordable. However, we do note that as CCNI’s research was

carried out in 2017, when the cost of sending a letter by 2nd class mail was 55p. There

therefore may have been an anchoring effect present, in that consumers are likely to have

based their responses on the prevailing price of 55p. Had the research been carried out

when the prevailing price was 58p, the average price at which consumers find Second Class

stamps unaffordable may have been higher.

Nonetheless, we treat survey responses to hypothetical questions on pricing with a degree

of caution as consumers tend to overstate their responsiveness to changes in price when

they do not have to follow through with taking a given action. It is also difficult to rely on

survey questions to a great degree of precision (i.e. the nearest pence), which is why we

have considered a range of sources instead of solely relying on questionnaires to

determine the current level of affordability.

CCNI also found that, on average, consumers without access to the internet and consumers

with a disability would find Second Class small parcels unaffordable at £2.83 and £2.85

respectively. Again, we treat the results from these hypothetical questions with caution.

As discussed in section 3, our consumer research suggests that postal consumers are

generally not particularly price sensitive and demand tends to be relatively inelastic. This

means that price increases would generally result in increased spending on post for

consumers, especially in circumstances where the consumer has a particular need to send

the postal items and does not have access to alternatives (such as email). For consumers at

risk of affordability issues, this may reduce income available for other expenditure.

Royal Mail hypothesised that this inelastic demand may be a result of consumers finding

current prices affordable, and prices remaining affordable despite a 10% or 20% increase.

We think it is at least equally as likely that the low price sensitivity is due to consumer

138 Residential Postal Tracker, QF1. 139 The Consumer Council, 2017. Postal Consumers in Northern Ireland: Experiences and Attitudes of Vulnerable Consumers and Businesses to the Postal Service. http://www.consumercouncil.org.uk/sites/default/files/original/Experiences_and_attitudes_of_vulnerable_consumers_and_businesses_to_the_postal_service.pdf.

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reliance on post. However, even if Royal Mail’s interpretation were to be correct, the

purpose of the affordability assessment is to measure whether consumers, especially

vulnerable consumers, would stop using the service, or forego spending on other essentials

to continue using it. Whilst only 10% of consumers responding that they would send fewer

letters in response a 10% price increase might seem small, this group of people may

represent the vulnerable consumers that the safeguard caps aims to protect.

Royal Mail also argued that our research showed that consumer satisfaction and value for

money are high. Data from our Residential Postal Tracker suggests that 86% of consumers

are satisfied with Royal Mail, with net dissatisfaction at only 4%. However, only 62% of

consumers were satisfied with the cost of postage – arguably the metric of greater

relevance to affordability.140 17% of consumers reported being dissatisfied with the cost,

with this figure increasing to 23% when considering only consumers aged over 65. This

demonstrates that satisfaction with the cost of postage using Royal Mail’s service is lower

than overall satisfaction with Royal Mail.

Overall, our assessment is that our consumer research suggests that postal services are

currently affordable for most. However, a minority may face affordability issues at current

prices, and this could increase as a result of a significant price increase.

It is likely that some of these consumers face circumstances where they would

unfortunately have concerns about the prices of the Second Class products, even at much

lower prices. This limited set of circumstances where a consumer suffers both significant

financial difficulty or very low income, and has a frequent need to send post items they

consider to be essential, reflects very particular circumstances and severe financial

hardship. We recognise that an increase in prices could have negative impacts on these

consumers, though unfortunately postal services may be unaffordable for some even if

their prices were reduced significantly.

Affordability for SMEs

Our consultation proposal

In the July 2018 Consultation, we set out that our approach to identifying businesses which

are at risk of affordability issues as those that view post as a critical input to their

businesses commercial proposition; those that lack a good alternative to stamp products

and those that have a high spend on post relative to their turnover. We estimated this only

applied to a very small number of SMEs in the UK.

Stakeholder responses

CCNI broadly agreed with our view that “if the postal service is affordable to residential

consumers it is likely to be the same for almost all SME’s”.141

140 Residential Postal Tracker, QG3_7. 141 CCNI’s non-confidential response, paragraph 6.28.

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There were no other stakeholder comments on the affordability of Second Class postal

services for SMEs.

Our assessment

In general, we consider that, if postal services are affordable for residential consumers,

including potentially vulnerable consumers, then they are likely to be affordable for almost

all SMEs as well. As in our 2013 Report, our approach to identifying businesses which are

potentially at risk from affordability issues is to identify businesses that satisfy the three

above-mentioned conditions, which we measure using market research data, namely:

• universal postal services are a critical input to the business’ commercial proposition:

we measure this condition by reference to businesses that say mail is ‘core’ to their

operations;

• the business lacks good alternatives to stamp products: we measure this condition by

reference to businesses with reported mail spend of below £100/month, as below this

level a meter mail product is unlikely to be significantly cheaper; and

• the cost of post is important for the business’s financial position: we assume this

condition is satisfied where postal spending is high relative to turnover; given that

condition ii) requires spending to be low, we measure this condition iii) based on

businesses with a relatively low annual turnover (of less than £50,000).

Taken together, we estimate that just 2.3% of UK SMEs would satisfy all three conditions,

based on our assessment of responses from our Business Postal Tracker.142 This equates to

around 131,100 SMEs. We estimated this group comprised 2.4% of UK SMEs in 2013. We

recognise that there may be some variation within this, for example if post is critical to a

greater proportion of SMEs in remote rural areas.143 However, our evidence does not

suggest a significantly greater proportion of SMEs in a given region would be at risk of

affordability issues.

Importantly, this is an estimate of the maximum number of businesses that could be at risk

of facing affordability issues. The actual number at risk is likely to be lower still as even for

businesses that are dependent on post it is unlikely that the price of Second Class stamp

products would be the main determinant of financial viability.

In 2017, business insolvency rates were around 0.5%144, indicating that in general relatively

few active businesses have faced financial viability issues.

142 Business Postal Tracker, QC2a, QC7 and QV1b. 143 For example, we note CAS research that found that one in five (19%) Scottish SMEs described post as core to their business operations (businesses which state they could not function without it) – this figure is higher (29%) for businesses in remote rural areas (Citizens Advice Scotland/Consumer Futures Unit, 2018. Delivering for Business: Scottish SMEs use of Postal Services, paragraph 4.1. https://www.cas.org.uk/system/files/publications/delivering_for_business_-_scottish_smes_use_of_postal_services.pdf). 144 The Insolvency Service, 2018. Estimated Company Insolvency Rate in the United Kingdom, January to December 2017. https://www.gov.uk/government/statistics/estimated-company-insolvency-rate-in-the-united-kingdom-january-to-december-2017. This estimate covers all UK businesses, but as SMEs represent 99.9% of all businesses we consider this is representative of SMEs.

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Based on this assessment, we consider that Second Class postal services are highly likely to

be affordable for almost all SMEs. We have not seen evidence to suggest that SMEs

currently face affordability issues, or may be likely to do so in future.

International comparisons

Our consultation proposals

In the July 2018 Consultation, we benchmarked Royal Mail’s price for Second Class Stamp

letters against the prices of comparable postal services in four other European countries –

France, Sweden, Poland and Italy. We noted that variation in the key characteristics of

these services made it difficult to make direct comparisons between the prices of each

country. Nevertheless, we found that, in 2017, at 56p and £1.22, Royal Mail’s prices for

Second Class standard and large letters compared relatively favourably in relation to the

other countries.

Stakeholder responses

Royal Mail noted that out of the 15 EU and EFTA countries who offered a Second Class

Stamp service in 2018, its price of 58p is the second cheapest.145 Further, it argued that this

price is well below the European mean average of 74p and that the proposed level of the

letters cap – 65p – is 12% below the European average. Given this, Royal Mail stated that

the level of the safeguard cap should be significantly higher, and that prices would remain

affordable for customers, including the vast majority of vulnerable consumers, if it were.

Our assessment

Although the EU Postal Services Directive requires a degree of harmonisation in postal

services across the EU, there remains variation in universal postal services between

different European countries, as well as variation in pricing structure and product and

delivery specification. For example, many European countries do not offer a Second Class

service to consumers, while others (such as France) offer Third Class. In addition, costs vary

due to factors such as geography and quality of service standards. However, despite this

variation, we consider that observing how Royal Mail’s Second Class prices compare to

similar services in other countries provides useful context.

Figure 4.5 shows Second Class stamp prices in 2017 in a number of European countries

which offer a Second Class service. Pricing structure varies between the countries included

in Figure 4.5. Universal service providers in other comparable countries typically have

three sizes of letter products – ‘small,’ ‘standard’ and ‘large’ – whereas Royal Mail has two

– ‘standard letters’ (equivalent to other countries’ ‘small’ and ‘standard’ letters) and ‘large

letters.’146 In effect, this means that consumers in the UK pay a single price to send a

145 Royal Mail’s non-confidential response, page 14. 146 A small letter is based on a DL envelope, a standard letter a C5 envelope and a large letter a C4 envelope.

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standard letter that meets the dimension of ‘small’ and ‘standard’ sized letters in other

counties.

Figure 4.5: 2017 Second Class stamp prices in selected European countries which offer Second

Class services

Source: WIK/Ofcom analysis.147 Prices as at September 2017. Conversion to GBP calculated by European

Commission Currency Converter.148 Small letter: 110mm x 220mm x 5mm, 20g or less. Standard letter: 229mm

x 162mm x 5mm, 100g or less. Large letter: 324mm x 224mm x 25mm, 101g or 150g.

Note delivery specification varies between country (2016): UK 1C (D+1) 2C (D+3); France 1C (D+1) 2C (D+2);

Sweden 1C (D+1) 2C (D+3); Germany 1C (D+1); Netherlands 1C (D+1); Poland 1C (D+1) 2C (D+3); Spain 1C (D+3);

Italy 1C (D+1/2/3) 2C (D+4).

At 56p and £1.22 in 2017, Royal Mail’s price for Second Class stamp letters was relatively

low in comparison to the other European countries we considered.149

Royal Mail’s analysis reported the average price of a second class 0-100g letter as of

January 2018 for the 15 EU and EFTA members who offer a second class service. Its price of

58p ranks it as the second cheapest Second Class service in Europe.

These findings are not dissimilar to ours, although as previously noted, differences in the

key characteristics of these services make it difficult to draw strong conclusions from either

147 Figure 4.5 comprises countries considered in the WIK/Ofcom analysis which offer services broadly comparable to Royal Mail’s Second Class standard letter and large letter services. 148 See: http://ec.europa.eu/budget/contracts_grants/info_contracts/inforeuro/index_en.cfm. 149 We note that Royal Mail announced price increases for 2018/19 which took effect on 26 March 2018. This does not change our assessment of UK stamp prices compared to other countries. For most recent price list see footnote 28.

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piece of analysis. Whilst the European mean price for a Second Class 0-100g letter is 74p,

and the European median price is 68p, our cap of 65p is not significantly cheaper than

either measure.150

Our conclusions on the affordability analysis

As our analysis shows, it is difficult to measure affordability for post. Given low levels of

spending, measures such as a share of income may not show affordability issues that arise

where price and the need to send essential post requires consumers to cut back on other

essentials or not send post that they consider essential. In addition, there are diverse

groups of potentially vulnerable consumers, who have experienced different changes since

our last review and may be affected differently by price increases.

Taking these considerations into account, we recognise that there is a range of evidence

and no single price point emerges as clearly being the limit of affordability. However,

determining the appropriate level of the safeguard caps requires us to identify a specific

limit. This requires regulatory judgment, balancing different evidence and the likely effects

on different groups of consumers.

In several areas, little has changed since 2013. Postal services still make up a low share of

income, and the majority of consumers do not report experiencing affordability issues.

However, real disposable incomes have increased moderately since 2013, including for the

lowest income decile. This suggests an increase in affordability. We have therefore used

the level of increase for the lowest income decile (7.6%) as an upper bound for our

consideration of an increase in affordability.

Other evidence suggests a more cautious approach. Disposable incomes for low income

retired households have increased at a slower rate (1.9% over 2012/13 to 2016/17).

Further, for the lowest income decile, disposable incomes after housing costs have

decreased by 3.7% (although the lowest income quintile has experienced an increase of

6.8%). Another measure of household budgets, total household expenditure has increased

more moderately over the same time period (2.2% for the bottom income decile). Postal

spending is seasonal, meaning that peaks in postal spending could make issues of

affordability more acute at certain times of the year. In addition, our consumer research

suggests a minority of households face affordability issues at current prices. A substantial

increase in prices could increase the proportion of households at risk of affordability issues

with respect to postal services.

In our judgment, the evidence suggests that an increase of 5% in real terms above the

current level of the caps would not render the Second Class products unaffordable for

either consumers generally or a significant majority of those we have identified as

potentially vulnerable. Royal Mail has stated that it believes prices would remain

affordable if the cap was increased in real terms by more than 5%. Whilst noting the

difficulty in identifying a specific price as the limit of affordability, the potential for adverse

150 Royal Mail non-confidential response, Figure 3.

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effects on some vulnerable consumers and the evidence of changes since 2013 lead us to

judge that a larger increase than 5% should be considered unaffordable at this time.

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5. Commercial flexibility

Introduction and summary

5.1 We explained in section 2 that, when imposing tariffs on universal postal services, we are

required under section 36(5) of the PSA 2011, in addition to ensuring prices are affordable,

to take account of the costs of providing the universal service and to ensure the level of

the tariff provides Royal Mail (i.e. the designated universal service provider) with

incentives to provide the service efficiently. In addition, and consistent with the overall

regulatory framework for postal services also discussed in section 2, we consider it

important that the level of the safeguard caps allows Royal Mail to make a reasonable

commercial rate of return on the safeguarded products.

5.2 The July 2018 Consultation set out our view that the safeguard caps have afforded Royal

Mail sufficient pricing flexibility since their inception to ensure that the safeguarded

products make a reasonable commercial rate of return.

5.3 Having considered consultation responses as well as recent market developments, we

remain of the view that the headroom of approximately 29% under the basket cap affords

Royal Mail sufficient commercial flexibility. Whereas, we consider that the remaining

headroom under the standard letter cap (of less than 5%) means that, if left unchanged,

Royal Mail’s commercial flexibility to increase letter prices would be eroded within 2-3

years.

5.4 In this section, we set out our assessment of the commercial flexibility provided by the

safeguard caps at their current levels, how this has changed over time and how this will

change under our decisions set out in this statement. To provide context to this

assessment, we also consider the costs Royal Mail incurs in providing the safeguarded

products and consider the financial sustainability of the universal postal service.

5.5 This section summarises our consultation position and stakeholder responses, and sets out

our commercial flexibility analysis, having taken those responses into account and having

considered the latest view on sustainability.

Pricing headroom under the safeguard caps

Our consultation proposals

5.6 In the July 2018 Consultation, we found that, while we consider that headroom of

approximately 29% under the basket cap affords Royal Mail considerable commercial

flexibility, the available headroom under the standard letter cap has diminished over time

and now stands at less than 5%. We considered it likely that if the standard letter cap were

left unchanged Royal Mail’s commercial flexibility to increase prices above inflation would

be eroded within 2-3 years.

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Stakeholder responses

5.7 Royal Mail believes that the level of the standard letter cap should be increased to provide

it with more flexibility to allow it to respond to changes in market dynamics. It noted that

the impact of the safeguard caps extends beyond the Second Class products; that First

Class stamp and meter products are interdependent on the price of the Second Class

products, and should the safeguard caps be set too low, Royal Mail would be limited in its

ability to respond to market dynamics using its pricing levers. However, Royal Mail did not

propose the level at which it would have sufficient pricing flexibility under the standard

letter cap. In addition, Royal Mail also asked what action Ofcom would take in the event

that market conditions were to change very quickly. Royal Mail did not comment on the

level of headroom currently afforded to it under the basket cap.

5.8 Conversely, MCF considers that the standard letter cap should be retained at its current

level and the basket cap should be reduced, so that it can act as a mechanism to encourage

efficiency.

5.9 Hermes considers that the fact that Royal Mail is pricing so far below the basket cap

suggests that the pricing of the products in the basket is not fully reflective of cost and that

the basket cap should be removed altogether.

5.10 The consumer groups151 broadly agreed with our assessment of commercial flexibility,

although they did highlight some affordability concerns in relation to the headroom

currently afforded to Royal Mail under the basket cap (see paragraphs 4.31 – 4.59 for our

assessment). CAS in particular noted that it considered that the level of the caps would not

overly restrict Royal Mail’s pricing freedom.

Our assessment

5.11 As set out in section 2, Royal Mail increased prices significantly for most of the safeguarded

products in 2012/13 after the removal of the previous price control regime. In subsequent

years, Royal Mail has chosen to increase the price of standard letters by a relatively

constant amount, with annual price increases broadly in line with RPI. For parcels, the

introduction of size-based pricing in 2013 led to a very significant increase in the prices of

some parcels products, with some products effectively increasing in price by more than

100%. However, subsequent changes to its size-based pricing policy later in 2013 and in

2014 resulted in some of these products reducing in price. Royal Mail has increased prices

of products within the basket cap more conservatively since 2015.

5.12 As a consequence of these pricing decisions, Royal Mail currently has significant headroom

under the basket cap. As shown in Figure 5.1, it is currently pricing the products within the

basket at approximately 29% below the cap.152 The amount of headroom afforded by the

151 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI. 152 We note that the safeguard cap is set by reference to our assessment of the affordability of the Second Class products and Royal Mail’s commercial flexibility, not by reference to cost, and therefore the level of headroom under the cap is not indicative of the relationship between price and cost.

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cap has been increasingly steadily by around 3% year on year due to Royal Mail’s pricing

policy for these products in recent years. By contrast, the headroom available under the

standard letter safeguard cap has reduced each year since 2013/14 as a result of Royal

Mail’s pricing decisions, with the price of a Second Class stamp now just under 5% below

the standard letter cap (58p against a permitted maximum of 60p in 2018/19). This is

despite Royal Mail increasing prices by 1-2p per year on average during that period.

Figure 5.1: Percentage headroom under the safeguard caps, 2012/13 to 2018/19

Source: Second Class safeguard cap compliance submissions as part of Royal Mail Regulatory Financial

Reporting Information.

5.13 Prior to publishing the July 2018 Consultation, we sought information from Royal Mail

under our formal powers to understand why it has not chosen to make full use of the

flexibility afforded to it under the safeguard caps. Royal Mail’s internal documents153 reveal

that political, reputational and regulatory risks are amongst the factors its considers with

respect to above inflation price increases for standard letters. This may partly explain why

it has chosen to increase prices of standard letters relatively conservatively since 2013/14,

rather than pricing to the level of the cap.

5.14 In respect of parcels, there is evidence from Royal Mail’s internal documents154 which

suggests it is concerned that overcapacity in the market increases the risk of losing volume

to competitors. It is possible that Royal Mail is hesitant to exploit the available headroom

under the basket cap given that when it last sought to do this via the introduction of size-

153 Royal Mail response dated 6 June 2018 to s.55 Notice, []. 154 Royal Mail response dated 6 June 2018 to s.55 Notice, [].

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based pricing in 2013, it resulted in a significantly greater loss of volume than Royal Mail

had anticipated.

5.15 As set out in section 3, Royal Mail continues to have a significant degree of pricing power in

both single piece large letters and small and medium parcels up to 2kg, and absent

regulation, Royal Mail would be able to increase prices materially. We therefore continue

to believe that the basket cap is necessary.

5.16 Overall, we believe that the headroom under the basket cap of approximately 29%, which

is increasing over time, affords Royal Mail considerable commercial flexibility, which we

consider assists in avoiding a material effect on wider financeability. We consider that the

significant headroom under the basket safeguard cap ensures that the effect of this cap on

Royal Mail’s pricing freedom is minimal and does not prevent it from making a reasonable

commercial rate of return. Given that the cap works on a volume weighted average basis,

Royal Mail has the ability to increase the prices of some products within the cap by even

more than 29% should it consider it necessary to do so, provided that price increases are

such that the overall level of the cap is not breached. This provides an additional degree of

pricing flexibility which a narrower cap might not provide and ensures Royal Mail has the

flexibility to change its products to better suit consumer needs as they evolve, should that

be necessary. For these reasons, we do not consider there is a need to change the level of

the basket cap to allow additional flexibility.

5.17 In response to our consultation, consumer groups155 expressed concerns that this flexibility

could allow Royal Mail to implement substantial price increases for individual products,

and that this could create affordability issues. In theory, Royal Mail’s pricing power and the

structure of the basket cap could give it the ability to make significant price increases for a

single product if it left the price of other products unchanged. However, we think it is

unlikely that Royal Mail would have the incentive to adopt such a pricing strategy. Royal

Mail has commercial incentives to set an efficient structure of prices for products within

the basket cap, and its historical pricing behaviour demonstrates the importance it places

on maintaining consistent pricing differentials between products. Further, we consider

affordability in the round, and a substantial increase in an individual product would be

offset by no or little changes in the price of other products in the basket in order to comply

with the cap.

5.18 However, the remaining headroom under the standard letter cap is less than 5% and is

decreasing over time, despite Royal Mail increasing prices by only 1-2p per year in recent

years. If this were left unchanged, and Royal Mail continued to increase prices annually

broadly in line with RPI inflation, it is likely that Royal Mail would exhaust the remaining

headroom within the next 2-3 years meaning that the cap would have a binding impact on

its pricing, and therefore impact Royal Mail’s pricing flexibility. We have not seen evidence

to suggest that a larger increase to the safeguard cap is required to ensure pricing

flexibility, although we do consider that increasing the current standard letter cap as

proposed in the July 2018 Consultation may give Royal Mail more flexibility over some

155 See non-confidential responses to Ofcom’s July 2018 Consultation from Citizens Advice, CAS and CCNI.

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products in the basket cap, to the extent that Royal Mail maintains price differentials

between certain Second Class products, for example by allowing it greater freedom over

the level of price increases that could be implemented whilst maintaining a consistent

price differential between standard and large letters.

5.19 Overall, we believe that increasing the standard letter cap by 5% affords Royal Mail

sufficient commercial flexibility to make a reasonable commercial rate of return, which we

consider necessary to avoid a material effect on wider financeability in respect of the

universal service. Our analysis shows that raising the level of the standard letter cap will

grant Royal Mail sufficient headroom to continue making price increases in line with RPI

(the same basis on which it has done over recent years, see paragraph 2.33 above) until

2024. Should market conditions change quickly, nothing in this decision would preclude us

from taking prompt action; we consider that in such events we could take steps to respond

quickly.

Costs of providing the safeguarded products

Our consultation proposals

5.20 In our July 2018 Consultation, we found that, in general, Second Class standard letters are

profitable to Royal Mail, while in aggregate the products within the basket cap have earned

a significantly lower return and have been loss making in some years.156 Taken together

however, we observed that the products within the safeguard caps are profitable to Royal

Mail, and, in each year, have made a higher rate of return than Royal Mail’s Reported

Business157 overall.

Stakeholder responses

5.21 Broadly, stakeholders agree with our analysis of profitability and returns. Royal Mail

submitted that, when considering the reasonable commercial rate of return, the analysis

should focus on the returns for the Reported Business. It considers that product specific

margins in isolation are misleading in network businesses.

Our assessment

5.22 In considering the relationship between Royal Mail’s prices for universal services and the

costs it incurs in providing these services, we think it is important to take into account the

specific features of Royal Mail’s network. As the postal industry is a network business with

many costs that are shared between different services, the fully allocated costs of

individual services depend on the scale and type of other services delivered over the same

network. This could cause the costs of providing different services to vary significantly. For

156 Royal Mail Regulatory Financial Reporting Information. 157 The Reported Business is part of Royal Mail’s business responsible for the universal service, which requires Royal Mail to collect and deliver letters and parcels a minimum number of days a week, at an affordable and uniform price to all UK addresses.

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example, if there was a significantly lower volume of business mail (which makes up the

majority of items carried over the network), the average cost of all mail products would

increase.

5.23 Therefore, in order to ensure that the provision of the universal postal service remains

financially sustainable, Royal Mail has incentives to set prices across its different mail

products in a manner that maximises overall mail volumes. This, in turn, should help

contain costs and prices for all mail users, but it does also mean that the reported

accounting margins and profitability across mail services will vary, again possibly

significantly.

5.24 We continue to believe that our analysis, which focuses on returns for the Reported

Business, whilst also taking into consideration other factors such as product specific

margins, is the correct approach. Looking at the profitability of the Reported Business

allows us to assess the costs of providing these products, which includes the safeguard

products, independently of decisions on cost allocation for individual products. The

product specific figures remain relevant because they relate to the profitability of the

specific products on which we are imposing regulation.

5.25 As set out in the Annual Monitoring Update 2017/18 and in Figure 5.2 below, Royal Mail’s

Reported Business recorded revenues of £7,121m in 2017/18. £2,824m of this revenue was

accounted for by universal services, which equates to approximately 40% of Reported

Business revenues. Second Class services accounted for £880m in revenue, including

revenue across all payment methods (stamp, meter and account), representing about 12%

of revenue. Stamp products which accounted for £[] in 2017/18, represent <10% of

Reported Business revenue. Within this, Second Class stamp standard letters in scope of

the safeguard cap accounted for £[]158, or <5% of revenue, and Second Class stamp large

letters and parcels in scope of the safeguard cap accounted for £[]159, or <5% of

revenue.160

158 []. 159 []. 160 On 15 January 2019, Royal Mail submitted that the Second Class stamp large letters and parcels in scope of the safeguard cap accounted for £[]rather than £[]. We have recalculated that the resulting profit margins set out in paragraph 5.27 below would change from []% to []% for Second Class large letters and small and medium parcels and taken together, the products covered by both of the safeguard caps would make a rate of return of []%, rather than []% in 2017/18. We have considered these revised figures on their face value and do not consider that these changes have an impact on the decisions set out in this statement. We will however, investigate the reasons for the difference in these figures, which were originally submitted to us in the regulatory financial accounts (confidential) technical appendices for the costing manual (volumes) and the Second Class safeguard caps compliance submission (prices) pursuant to the universal service provider account condition (USPAC) and the Regulatory Accounting Guidelines (RAG).

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Figure 5.2: Reported Business revenues split by product group, format and universal service

product 2017/18

Source: Royal Mail Regulatory Financial Statements and unaudited submissions from Royal Mail.

*Other mainly consists of unaddressed and international mail.

** Includes special delivery.

5.26 Data provided by Royal Mail as part of its regulatory reporting shows that the costs it

incurs in providing the products in scope of the safeguard caps on a Fully Allocated Cost

basis in 2017/18 were £[], with the cost of standard letters representing £[] and £[]

attributable to large letters and small and medium parcels.

5.27 This resulted in a reported profit margin of []% for Second Class standard letters and

[]% for Second Class large letters and small and medium parcels. Taken together, the

products covered by each of the safeguard caps made a rate of return of []% in 2017/18.

5.28 Royal Mail’s Regulatory Financial Reporting Information therefore, in general indicates that

Second Class standard letters are profitable to Royal Mail, while in aggregate the products

within the basket cap have earned a significantly lower return and have been loss making

in some years.161 Taken together, we observe that the products within the safeguard caps

are profitable to Royal Mail, and, in each year, have made a higher rate of return than

Royal Mail’s Reported Business overall. We consider that our analysis, which focuses on

the Reported Business, but which also takes into consideration other factors such as

product specific margins is the correct approach as it provides context and allows us to

assess the financial position of the safeguarded products in the round.

The financial sustainability of the universal postal service

Our consultation proposals

5.29 In the July 2018 Consultation, we said that the universal postal service is likely to remain

financially sustainable in the immediate future, although it faces a number of credible

downside scenarios. We also consider that Royal Mail retains incentives to improve

efficiency, and we expect Royal Mail’s efficiency performance to improve now that it has

reached an agreement on pension reform.

161 Royal Mail Regulatory Financial Reporting Information.

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Stakeholder responses

5.30 With the exception of Royal Mail, MCF and Whistl, stakeholders did not make specific

comments in relation to the financial sustainability of the universal postal service. In its

submission, Royal Mail recognised that it is in a stronger financial position than in 2012

when the safeguard caps were introduced, however noted it is outside the 5-10% EBIT

margin range which we consider to be consistent with a reasonable commercial rate of

return for a financially sustainable universal service in the longer term, it noted that it is

[]. Royal Mail further notes [].

5.31 Whistl raised concerns about Royal Mail’s efficiency incentives, believing our proposals do

not go far enough. In addition, MCF considers that Ofcom should retain the current level of

the standard letter cap and reduce the basket cap in order that the caps become a

mechanism for Royal Mail to improve its efficiency. CCNI also stated that Ofcom should

monitor the efficiencies made by Royal Mail.

Our assessment

5.32 In our Annual Monitoring Update on the Postal Market: Financial Year 2016/17 (“Annual

Monitoring Update 2016/17”), we noted that the 2017/18 financeability EBIT margin for

Royal Mail’s Reported Business fell by 0.2 percentage points from 4.6% in the prior year to

4.4%.162 This is below the 5% - 10% range that we consider to be consistent with a

reasonable commercial rate of return for a financially sustainable universal service in the

longer term.163 Figure 5.3 shows the Reported Business Financeability EBIT margin over the

period 2012/13 to 2017/18.

162 Ofcom, 2017. Annual Monitoring Update on the Postal Market: Financial Year 2016/17, paragraph 7.10. https://www.ofcom.org.uk/__data/assets/pdf_file/0019/108082/postal-annual-monitoring-report-2016-2017.pdf. 163 2017 Statement, paragraphs 3.54-3.63.

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Figure 5.3: Reported Business Financeability EBIT margin, 2013/14 to 2017/18

Source: Royal Mail audited regulatory accounts and unpublished submissions from Royal Mail.

5.33 Despite the fall in EBIT margin to 4.4%, in the Annual Monitoring Update 2017/18, we said

that we consider the universal service is likely to remain financially sustainable in the

immediate future. Our key reasons are:

• the Reported Business is currently profitable; and

• the financial position and financial health metrics (including credit rating) of Royal Mail

Group do not indicate any short-term financial health issues.

5.34 In our Annual Monitoring Update 2016/17164, we recognised that there are various

downside scenarios which have the potential to have a negative impact on the financial

sustainability of the universal service. These downside risks included the impact of

potential industrial action, affordability of the pension scheme going forward, increased

competition for bulk parcels, where Royal Mail competes with other parcel operators for

contracts with online retailers, and economic and market downturn.

5.35 Since that time, Royal Mail has concluded a pay and pensions agreement, which we

expected would address some of those downside scenarios and result in Royal Mail being

better placed to make efficiency improvements in the short to medium term compared to

recent years. However, Royal Mail’s performance to date in 2018-19, particularly in

relation to productivity, has not matched such expectations. In previous years, we

considered that continued progress on efficiency was likely to improve the profitability of

the Reported Business and help ensure the financial sustainability of the universal service.

This is therefore of concern to us, and we will continue to monitor developments closely.

164 Annual Monitoring Update 2016/17.

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5.36 As part of our monitoring programme, we engage regularly with Royal Mail’s senior

management to understand their perspective on the future on the universal service and

plans they have in place to address any performance issues within the part of the business

responsible for delivering the universal service.

5.37 Following Royal Mail’s trading update in October 2018, in its results for the half year ended

23 September 2018, its CEO stated “it was very disappointing to have to announce in early

October our poor UK productivity and cost performance”165 and that Royal Mail was taking

actions to address its current performance issues. In its response to the July 2018

Consultation, Whistl said that market conditions and shareholder discipline do not go far

enough to provide efficiency incentives. MCF also argued that we should retain the level of

the current standard letter cap and reduce the basket cap in order to encourage

efficiencies. In this case, we consider that price regulation is not the best means of

incentivising efficiency, and we believe that Royal Mail has strong incentives to improve its

efficiency in future to remain financially sustainable. Progress on efficiency is likely to

improve the profitability of the Reported Business and help ensure the financial

sustainability of the universal service. Further, we believe that market conditions and

shareholder discipline continue to provide efficiency incentives.

5.38 With respect to the longer-term sustainability of the universal service, we noted that it is

dependent on Royal Mail’s ability to grow parcels’ revenues sufficiently to offset letters

revenue decline and / or remove costs from the business. As part of our monitoring each

year, we review Royal Mail’s expectations of future performance to form a view of the

medium- to long-term outlook of the Reported Business.

Our conclusions on commercial flexibility

5.39 Overall, we observe that the current levels of the safeguard caps have not prevented Royal

Mail from making a reasonable commercial rate of return on the safeguarded products.

While Royal Mail tends to earn a greater rate of return on standard letters compared to

the aggregate rate of return on products within the basket cap, we note that the

headroom afforded under the basket cap is such that Royal Mail could have increased the

prices of these products in order to improve the profitability of these products.

5.40 We also observe that, while the level of commercial flexibility afforded by the basket cap is

significant and growing, the level of flexibility afforded by the standard letter cap has

diminished over time and now stands at less than 5%. Should the level of this standard

letter cap remain unchanged, it is likely that Royal Mail’s commercial flexibility to increase

prices in line with RPI inflation (as it has done over recent years) could be eroded within 2-

3 years. Our analysis shows that raising the level of the standard letter cap by 5% in real

terms will grant Royal Mail sufficient headroom to continue making price increases in line

with RPI until 2024.

165 Royal Mail, 2018. Annual Report and Financial Statements 2017-18, page 4.

https://www.royalmailgroup.com/media/10169/royal-mail-group-annual-report-and-accounts-2017-18.pdf.

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5.41 As set out in the Annual Monitoring Update 2017/18, we continue to consider that the

universal service is likely to remain financially sustainable in the immediate future, given

that the Reported Business is currently profitable; and the financial position and financial

health metrics (including credit rating) of Royal Mail do not indicate any short-term

financial health issues. We do, however, recognise that there are various possible

downside scenarios which have the potential to have an adverse impact on the financial

sustainability of the universal service, which we will continue to monitor closely.

5.42 Taking all of this together, we believe that our decision on the caps set out in this

statement afford Royal Mail sufficient commercial flexibility to make a reasonable

commercial rate of return, which we consider is necessary to avoid a material effect on

wider financeability in respect of the universal service.

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6. Our decision

The case for the retention of the safeguard caps

6.1 As set out in section 2, we concluded in our recent 2017 Statement that it was necessary to

retain the safeguard caps on the Second Class products, primarily to ensure vulnerable

consumers can access a basic universal service at affordable prices. This was on the basis

that Royal Mail is a near monopolist in single piece letters and therefore has the ability to

profitably raise prices above the current level of the safeguard caps. In parcels, we noted

that Royal Mail’s significant share of the single piece parcel sector combined with the

extensive Post Office network and strong brand awareness, provides it with a significant

degree of pricing power. We therefore concluded that we could not rely on competitive

constraints to prevent Royal Mail from raising prices. Our further analysis set out in this

statement supports our 2017 Statement conclusion.

6.2 Based on the analysis set out in section 3 (which takes account of all stakeholder

comments received in response to the July 2018 Consultation), we remain of the view that

competitive constraints are insufficient to prevent Royal Mail from raising the prices of the

safeguarded products significantly, and that the safeguard caps continue to be necessary.

In addition, we do not consider there has been a change in competitive conditions that

would suggest altering the structure or scope of the safeguard caps.

6.3 For these reasons, and in light of our analysis of affordability and commercial flexibility in

sections 4 and 5, we continue to believe it is necessary and proportionate to impose

safeguard caps on Royal Mail’s Second Class stamp products and that the structure and

scope of the safeguard caps should remain the same.

Setting the level of the safeguard caps

6.4 We have decided to set the levels of the caps as proposed in our July 2018 Consultation.

6.5 In considering the appropriate level of the safeguard caps, we have taken account of all

stakeholder comments received in response to the July 2018 Consultation, and we have

been guided, in particular, by our safeguard caps objectives discussed in section 2.

6.6 In summary, we are imposing the following levels:

• Standard letter safeguard cap: we propose that this cap should be increased from its

current level by 5% in real terms. This would take the effective upper limit of the

standard letter cap from 60p currently to 65p, thereafter each year on 1 April,

increasing by CPI.

• Basket safeguard cap: We do not propose to increase the level of the basket cap, and

therefore propose to retain the level of that cap at its current level, thereafter each

year on 1 April, increasing by CPI, including on 1 April 2019.

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6.7 We consider that these levels are appropriate in meeting our four safeguard caps

objectives for the reasons set out in this statement and summarised again below.

6.8 As set out in section 3, we remain of the view set out in our 2017 Statement that

competitive constraints are still insufficient to prevent Royal Mail from raising prices for

the products under the safeguard caps. Royal Mail remains a near-monopolist in standard

letters and large letters, with little threat of new entrants in the market. The risk of

triggering a step-change in e-substitution may act to constrain very substantial price

increases, but is unlikely to provide protection against smaller price increases, which may

nonetheless cause prices of the Second Class products to become unaffordable for some

consumers.

6.9 Though there is more competition in the parcels sector, this is limited for small and

medium single piece parcels, where Royal Mail retains a very high share of volumes and

revenues. Past competitor responses to very large price increases may lead Royal Mail to

act cautiously, but this is unlikely to constrain Royal Mail from implementing moderate

price increases, which may render the products unaffordable over time.

6.10 As set out in section 4, our judgment is that an increase of 5% in real terms above the

current levels of both the letter and the basket caps will not render the price of Second

Class services unaffordable for either consumers generally or a significant majority of those

we have identified as potentially vulnerable and by extension SMEs. However, as noted

above, increases of greater than 5% above the current caps could be considered

unaffordable, particularly for some vulnerable consumers.

6.11 Section 5 highlights that we continue to consider the universal service is likely to remain

financially sustainable in the immediate future, but that there are various possible

downside scenarios which have the potential to impact the financial sustainability of the

universal service negatively, which we will continue to monitor closely.

6.12 Taking our analysis together, we believe that increasing the standard letter cap by 5% and

maintaining the basket cap at its current level, affords Royal Mail sufficient commercial

flexibility to make a reasonable commercial rate of return, which we consider necessary to

avoid a material effect on wider financeability in respect of the universal service.

6.13 Increasing the standard letter cap by 5% in real terms takes the effective maximum price

that Royal Mail can charge for a Second Class standard letter to 65p from 1 April 2019.166

166 The precise upper limit of the cap will be set at 65.2p from April 2019. This is on the basis that the level of the cap is currently 60.65p. A 5% increase would take the level to 63.7p before inflation, and a further 2.4% increase (representing the rate of inflation for the 12 months ending September 2018) would take the upper limit of the cap to 65.2p (rounded to one decimal place). We note that currently Royal Mail charges in whole pence increments for the Second Class products. Therefore, when describing the level of the cap in this document, we round to the last whole pence (65p).

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Modifications to the DUSP conditions

6.14 Under the PSA 2011, Ofcom is under a duty to publish a notification prior to imposing or

modifying a regulatory condition such as the DUSP conditions. In the notification relating

to our proposed modifications to the safeguard caps we are required to:

• state that we are proposing to modify the condition specified in the notification;

• set out the effect of the modification(s);

• give our reasons for making the proposal; and

• specify the period within which representations may be made to us about our

proposal.

6.15 This notification was published in the July 2018 Consultation (see section 6 and Annex 5 to

the July 2018 Consultation). We set out below stakeholder comments received on our

proposed modifications to the DUSP conditions, together with our assessment and

decision on these modifications, which are reflected in our notification published in Annex

1 to this statement.

Our consultation proposals

6.16 In the July 2018 Consultation, we set out our proposed modifications to the DUSP

conditions to give effect to our policy proposals. This included amendments to give effect

to our proposed changes to the level of the standard letter cap, amendments to the

formulae for calculating the basket cap, amending the definition of ‘relevant year’ to

reflect our proposal to introduce the caps without a sunset clause and a clarificatory

amendment to make clear that Second Class products captured by the safeguard caps

should comprise traditional postage stamps or other types of labelling affixed to such items

to indicate the amount of postage paid, including where the postage has been sold

online.167

Stakeholder comments

6.17 Royal Mail was the only stakeholder that responded to our proposed modifications to the

DUSP conditions. Royal Mail submitted that it believes the caps are unnecessary because

DUSP Condition 1 (“DUSP 1”)168 already requires the provision of end-to-end services at

affordable prices. Further, Royal Mail stated that it did not agree with our proposal to

enable the caps to remain in place in perpetuity, rather the caps should remain in place for

the duration of the current regulatory framework, until March 2022. Royal Mail also asked

what action Ofcom would take in the event that market conditions were to change very

quickly.

167 The notification in Annex 5 of the July 2018 Consultation sets out our proposed modifications to DUSP 2 (the standard letters safeguard cap), which are specified in Schedule 1, and our proposed modifications to DUSP 3 (the basket safeguard cap), which are specified in Schedule 2. 168 Ofcom, 2013, DUSP Condition 1, https://www.ofcom.org.uk/__data/assets/pdf_file/0017/8351/dusp1.pdf.

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Our assessment

The safeguard caps continue to be necessary

6.18 We believe that the safeguard caps continue to be necessary, and that the requirement

under DUSP 1 to provide end-to-end services at affordable prices is not sufficient to

protect vulnerable consumers. DUSP 1 does not contain any measure of what affordability

means, nor does it specify how and to whom prices should be affordable.

6.19 Since 2012, we have made clear that it is important to ensure that a basic universal service

is available to all at affordable prices, and to ensure that users of postal services, especially

vulnerable consumers, are protected from on-going price increases. To ensure this, we

have imposed the safeguard caps on the Second Class products, having regard to our

general approach to assessing the affordability of universal postal services for residential

consumers and SMEs, as set out in the 2013 Report.

6.20 In our recent 2017 Statement, we found again that the safeguard caps should be

maintained in order to ensure that consumers, in particular vulnerable consumers,

continue to have access to a universal service at affordable prices. We have also

previously found that, if the safeguard caps ensured that a universal service product was

affordable to vulnerable consumers, it would be affordable to all residential consumers

and SMEs.

6.21 We therefore continue to believe that the safeguard caps remain necessary to provide the

necessary protection for vulnerable consumers, and consumers more generally.

Modifications to the standard letter safeguard cap (DUSP 2)

6.22 Currently, the standard letter safeguard cap (DUSP 2) sets the maximum price which Royal

Mail (as the designated universal service provider) is permitted to charge for the Second

Class standard letter product. For the first year which the cap was in operation (1 April

2012 to 31 March 2013), the maximum price was set at 55p. The cap permits the maximum

price to increase by CPI for each subsequent year (from 1 April to 31 March) of the control

period, which ends on 31 March 2019. The cap also imposes certain requirements on Royal

Mail (as the designated universal service provider) to aid Ofcom’s monitoring of the

safeguard cap and ensure compliance.

6.23 We continue to believe that this control is appropriate for the Second Class standard letter

stamp product. Consumers use significantly more Second Class standard letters than any

other Second Class format or price point and consumers tend to have greater awareness of

the price of standard letter products compared to large letter and parcel products,

reflecting the greater frequency of use of standard letter products. There is therefore

benefit in keeping in place a simple cap that allows customers to easily predict future

(maximum) prices. We are therefore retaining DUSP 2 as a standalone cap on Second Class

standard letters. This has the benefit of being simple to implement and straightforward for

all stakeholders to understand.

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6.24 Our main modification to the standard letter safeguard cap is to set the new maximum

price in relation to Second Class standard letters. The effect of the modification is to

introduce the new, increased maximum price of 65.2p in the first year of the control,

increasing with CPI thereafter. Additionally, and aside from our new definition of ‘Relevant

Year’ and the addition of a sunset clause (see below), we are implementing some minor

textual changes to DUSP 2.169

Modifications to the basket cap (DUSP 3)

6.25 The basket cap (DUSP 3) currently imposes on Royal Mail (as the designated universal

service provider) a maximum limit on the weighted average increase of the basket of

products (large letters and small and medium parcels up to 2kg) falling within the cap by

applying the formulae specified in DUSP 3.

6.26 This is on the basis that we consider it appropriate that Royal Mail should have commercial

freedom to determine the prices of individual products within this basket, in order to

ensure that it has the flexibility to change its products to better suit consumer needs as

they evolve, should that be necessary, and to ensure that the impact of the cap on its

pricing freedom is minimised subject to prices remaining affordable overall. The maximum

price increases by CPI for each year of the control period, until its expiry on 31 March 2019.

The cap also imposes certain requirements on Royal Mail (as the designated universal

service provider) to aid Ofcom’s monitoring of the safeguard cap and ensure compliance.

6.27 We are retaining the level of the basket cap at its current level in real terms, with the

maximum price limit increasing by CPI for each year that the cap remains in force. We

consider that this sets the basket cap on current prices and products in a transparent way.

The main effects of our modifications to the basket cap are:

• The formulae used to calculate the basket cap operate by reference to the ‘Base Year’,

which is currently defined as meaning the period beginning on 1 April 2011 and ending

31 March 2012. We have replaced that definition so that it refers to the period

beginning on 1 April 2018 and ending on 31 March 2019.

• We have included a list setting out the base year prices for the products caught by the

basket cap. We have amended the formulae to specify that the cap is set at 29.4%

above Royal Mail’s 2018/19 weighted average prices as at 17 January 2019 (which is

the headroom that Royal Mail currently has under the cap) plus the change in CPI

between the base year and the relevant year. We have altered the CPI adjustment

term in the formulae, to provide for a change to the level of the cap in line with the

change in CPI from 2018/19 to 2019/20.

6.28 Additionally, and aside from our new definition of ‘Relevant Year’ and the addition of a

sunset clause (see below), we are implementing some minor textual changes to DUSP 3.170

169 Annex 5 of the July 2018 Consultation contains a marked-up version of our proposed changes to DUSP 2. Our final changes modifying DUSP 2 are found in Schedule 1 to our notification published at Annex 1 to this statement. 170 Annex 5 of the July 2018 Consultation contains a marked-up version of our proposed changes to DUSP 3. Our final changes modifying DUSP 3 are found in Schedule 2 to our notification published at Annex 1 to this statement.

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Modifications to the definition of ‘Relevant Year’ to introduce a sunset clause in each of the safeguard caps (DUSP 2 and DUSP 3)

6.29 Currently, each of the safeguard caps (DUSP 2 and DUSP 3) define ‘Relevant Year’ as the

period running from 1 April to 31 March for the duration of the control period, which

commenced on 1 April 2012 and will expire on 31 March 2019.

6.30 In the July 2018 Consultation, we proposed not to fix an expiration date for each of the

caps set out in DUSP 2 and DUSP 3, and we therefore proposed to modify each of the

safeguard caps so that neither DUSP condition states a specific date at which the caps will

expire. We proposed that the new definition of ‘Relevant Year’ for each of DUSP 2 and

DUSP 3 should refer to any period of 12 consecutive months beginning on 1 April and

ending on 31 March.

6.31 In response to the July 2018 Consultation, Royal Mail submitted that it considered that the

new regulation should remain in place for the duration of the current regulatory

framework, until March 2022.

6.32 In our 2012 Statement, we imposed the regulatory framework for a period of seven years

in order to provide a sufficient period of regulatory stability for the management of Royal

Mail to fully address the challenges facing the business. We imposed the safeguard caps

for the same period, but noted that we would review the level of the cap in two to three

years, if required.

6.33 In 2017, we decided to maintain the 2012 approach to regulation for a further five years,

on the basis that we thought that a significant change in our regulatory approach would be

inappropriate and that maintaining the approach adopted in 2012 would best achieve our

duties under the CA 2003 and the PSA 2011.

6.34 Taking account of Royal Mail’s submission, we have decided to introduce a sunset clause in

each of the safeguard cap conditions (DUSP 2 and DUSP 3) such that they expire on 31

March 2024. As set out in our 2017 Statement, we anticipate reviewing the regulatory

regime again in 2022. We did not propose an expiration date for the safeguard caps in the

July 2018 Consultation in order to provide flexibility as to the exact timing of reassessing

and consulting on any future safeguard caps in light of the anticipated 2022 review. We

consider that imposing the safeguard caps until 31 March 2024 will afford us a similar level

of flexibility, whilst also giving Royal Mail formal reassurance that the safeguard caps

imposed in this statement will expire on 31 March 2024 at the latest.

6.35 However, we note that this introduction of a sunset clause does not preclude us from

taking prompt action in the event of material concerns regarding affordability for

consumers or Royal Mail’s ability to finance the universal postal service; we consider that

in such events we could take steps to respond quickly.

Modifications concerning the definition of the stamped products in each of the safeguard caps (DUSP 2 and 3)

6.36 We are modifying each of DUSP 2 and DUSP 3 to clarify that the Second Class products

captured by the safeguard caps will comprise traditional postage stamps or other types of

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labelling affixed to such items to indicate the amount of postage paid, including where the

postage has been sold online.

6.37 This clarificatory modification will reflect a practice already taking place; Second Class

standard letter and large letter stamps bought online are currently the same price as the

same ‘traditional’ stamp bought over-the-counter at a Post Office and elsewhere, whereas

small and medium parcels are currently cheaper to buy online. Moreover, we consider that

the safeguard caps should cover both ‘traditional’ postage stamps and the online variant in

order to effectively meet our safeguard caps objectives.

Legal tests

6.38 We consider that our decision (as reflected in our modifications to DUSP 2 and DUSP 3 as

set out in Annex 1) satisfies the relevant tests set out in Schedule 6 to the PSA 2011, which

must be met where we impose a regulatory condition, namely that it:

• is objectively justifiable;

• does not unduly discriminate against a particular person of a particular description of

persons;

• is proportionate; and

• is transparent in relation to what they are intended to achieve.

6.39 We consider that our modifications satisfy these tests. Our reasons are set out throughout

this statement. In summary, we consider that those tests are satisfied because:

• Objectively justifiable – we believe that our modifications are objectively justifiable,

because they seek to ensure that the relevant universal postal services remain

affordable, whilst taking account of the costs of providing the service and appropriate

incentives for Royal Mail to provide the relevant services efficiently. We also consider

that our modifications strike an appropriate balance between our safeguard caps

objectives.

• Not unduly discriminatory – we believe that our modifications are not unduly

discriminatory because they only affect the universal service provider in the UK (i.e.

Royal Mail) reflecting its unique position as the sole universal service provider. We also

note that the relevant universal postal services captured by the caps are required to be

uniformly priced across the UK. In addition, should Royal Mail decide to offer discounts

to the price of Second Class stamps (for example, if it chose to offer Christmas

discounts for vulnerable consumers), this would not impact the requirement to charge

no more than 65p at all other times (between 1 April 2019 to 31 March 2020) and to all

other customers.

• Proportionate – we believe that our modifications are proportionate because they

only impose requirements that we consider are appropriate and necessary to ensure

that our safeguard caps objectives (including the requirements set out in section 36(5)

of the PSA 2011, as reflected in those objectives) are met, without imposing any undue

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burden on Royal Mail in its capacity as the designated universal service provider. In

particular, we consider that the safeguard caps are being set at levels which take

account of affordability for vulnerable consumers, whilst still ensuring that Royal Mail

retains sufficient pricing flexibility to make a reasonable commercial rate of return on

the Second Class products.

• Transparent – we consider that our modifications are transparent because they clearly

set out the obligations we have imposed on Royal Mail in its capacity as the designated

universal service provider, particularly by clearly specifying the maximum prices that

Royal Mail is permitted to charge for the relevant services captured under the

respective caps.

6.40 In reaching our conclusions, we have also addressed in this statement the specific

requirements set out in section 36(5) of the PSA 2011 to ensure that, in imposing tariffs on

the relevant universal postal services, the prices of these services will be affordable (see

section 4). In addition, our conclusion takes account of the costs of providing the universal

service, alongside our related policy objective to ensure that Royal Mail is able to make a

reasonable commercial rate of return on the safeguarded products (see section 5).

6.41 Our assessment has also considered the extent to which the level of the caps may

incentivise efficiency improvements. As we set out in our 2012 Statement, the safeguard

caps are not intended, in and of themselves, solely to provide efficiency incentives to Royal

Mail. However, we are of the opinion that Royal Mail remains strongly incentivised to

pursue efficiency improvements to remain financially sustainable. We believe that Royal

Mail would remain incentivised even if it were to choose to immediately make use of all of

the additional flexibility afforded by our decisions.

6.42 Finally, in arriving at our decision, we have considered and acted in accordance with our

specific duty in section 29 of the PSA 2011 (see section 5 for our assessment of the

financial sustainability of the universal postal service) and our general duties in section 3 of

the CA 2003. In performing our principal duty under section 3 of the CA 2003, we have had

particular regard to those consumers identified as potentially vulnerable and how they

may be affected by any decision we may take with respect to the safeguard caps. Taking

into account the impact of our conclusions on each of consumers and Royal Mail, we

believe that the interests of citizens and consumers will be secured or furthered by our

modifications to the safeguard caps.

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A1. Statutory notification: Modified Designated USP Conditions 2 and 3

NOTIFICATION OF MODIFICATIONS TO DESIGNATED USP CONDITIONS 2 AND 3 PURSUANT TO SECTION 36 OF, AND IN ACCORDANCE WITH SECTION 53 OF, AND PARAGRAPH 3 OF SCHEDULE 6 TO, THE POSTAL SERVICES ACT 2011

BACKGROUND (A) On 27 March 2012, following consultation, Ofcom published a statement entitled ‘Securing the Universal Postal Service: Decision on the new regulatory framework’ 171 setting out various decisions, including the imposition on Royal Mail of designated USP conditions to make provision for matters set out in sections 36 and 37 of the Act, such as Designated USP Condition 2172 (the “initial DUSP 2”). (B) On 20 July 2012, following consultation, Ofcom published a statement entitled ‘Securing the Universal Postal Service: Safeguard cap for Large Letters and packets’173 setting out its decision to impose on Royal Mail another designated USP condition to make provision for matters set out in section 36 of the Act, namely Designated USP Condition 3 (the “initial DUSP 3”) (C) On 28 March 2013, following consultation, Ofcom published a statement entitled ‘Safeguard cap for Second Class Large Letters and packets: Statement on the proposed modifications to the safeguard cap condition (DUSP Condition 3)’174 setting out its decision to modify the initial DUSP 3 to correct an error in the drafting to ensure that the condition accurately implemented Ofcom’s intended original policy (the “amended DUSP 3”). (D) On 18 December 2017, following consultation, Ofcom published a statement entitled ‘Regulatory financial reporting for Royal Mail’175 setting out its decisions to modify both DUSP 2.2.4 of the initial DUSP 2 (the “amended DUSP 2”) and DUSP 3.2.4 of the amended DUSP 3 (the “further amended DUSP 3”), to require the data necessary to monitor compliance with the Second Class stamp safeguard caps one month after the implementation of any new prices.176 (E) On 26 July 2018, Ofcom published a consultation document entitled ‘Review of the Second Class Safeguard Caps 2019’177 setting out a notification of Ofcom’s proposals to modify the amended DUSP 2 and the further amended DUSP 3 contained in Annex 5 to that consultation document (the “July 2018 Notification”).

171 https://www.ofcom.org.uk/__data/assets/pdf_file/0029/74279/Securing-the-Universal-Postal-Service-statement.pdf. 172 See Schedule 2 to the statutory notification published in Annex 7 of Ofcom’s Statement of 27 March 2012: https://www.ofcom.org.uk/__data/assets/pdf_file/0019/71812/annex7.pdf. 173 https://www.ofcom.org.uk/__data/assets/pdf_file/0015/72042/statement.pdf. 174 https://www.ofcom.org.uk/__data/assets/pdf_file/0022/50566/statement.pdf. 175 https://www.ofcom.org.uk/__data/assets/pdf_file/0032/108869/financial-reporting-Royal-Mail.pdf. 176 See paragraphs 2 and 3 of the statutory notification published in Annex 3 of Ofcom’s Statement of 18 December 2017: https://www.ofcom.org.uk/__data/assets/pdf_file/0026/108872/Annex-3.-DUSP-Modification-Notification.pdf. 177 https://www.ofcom.org.uk/consultations-and-statements/category-1/review-second-class-stamp-safeguard-cap.

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(F) A copy of the July 2018 Notification was sent on 26 July 2018 to the Secretary of State in accordance with paragraph 5(1)(a) of Schedule 6 to the Act. (G) Ofcom invited representations about the proposals set out in the July 2018 Notification by 4 October 2018. Ofcom received responses from eight stakeholders to the July 2018 Notification. Ofcom has considered every such representation. In accordance with paragraph 3(5) of Schedule 6 to the Act, Ofcom has made the decision set out below to give effect, with some modifications (the nature of which are explained in the accompanying statement), to its proposals set out in the July 2018 Notification. The Secretary of State has not notified Ofcom of any international obligation of the United Kingdom for the purpose of Ofcom giving effect to those proposals.

DECISION 1. Ofcom hereby decides, in accordance with section 53 of, and paragraph 3 of Schedule 6 to, the Act and pursuant to its powers under section 36 of the Act, to modify DUSP 2 and DUSP 3 as set out in the July 2018 Notification―and with the modifications that Ofcom has made to the proposals in that Notification―in order to make further provision for matters set out in that section 36 and to impose that DUSP 2 and DUSP 3 on the universal service provider, i.e. Royal Mail. 2. The texts of DUSP 2 and DUSP 3 as modified by our above-mentioned decision are set out in Schedule 1 (for DUSP 2) and in Schedule 2 (for DUSP 3), respectively, to this Notification, which shall take effect on 1 April 2019. 3. The effect of, and Ofcom’s reasons for making, this decision are set out in the accompanying statement.

OFCOM’S DUTIES AND LEGAL TESTS 4. Ofcom is satisfied that this decision satisfies the general test in paragraph 1 of Schedule 6 to the Act. 5. In making this decision, Ofcom has considered and acted in accordance with its principal duty in section 29 of the Act and its general duties in section 3 of the Communications Act 2003.

INTERPRETATION 6. Except insofar as the context otherwise requires, words or expressions shall have the meaning assigned to them in this Notification and otherwise any word or expression shall have the same meaning as it has been ascribed for the purpose of Part 3 of the Act. 7. In this Notification— (a) “Act” means the Postal Services Act 2011 (c.5); (b) “DUSP 2” means Designated USP Condition 2 referred to in recital (A) to this Notification as amended by the modification referred to in recital (D); (c) “DUSP 3” means Designated USP Condition 3 referred to in recital (B) to this Notification as amended by the modifications referred to in recitals (C) and (D) respectively;

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(d) “Ofcom” means the Office of Communications; and (e) “Royal Mail” means Royal Mail Group Ltd, whose registered company number in England and Wales is 04138203. 8. For the purpose of interpreting this Notification— (a) headings and titles shall be disregarded; (b) expressions cognate with those referred to in this Notification shall be construed accordingly; and (c) the Interpretation Act 1978 (c. 30) shall apply as if this Notification were an Act of Parliament. 9. Schedules 1 and 2 to this Notification shall form part of this Notification. Signed by

Marina Gibbs

Competition Policy Director

A person duly authorised by Ofcom under paragraph 18 of the Schedule to the Office of

Communications Act 2002

17 January 2019

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SCHEDULE 1

DESIGNATED USP CONDITION 2

SAFEGUARD CAP PRICE CONTROL FOR SECOND CLASS STANDARD LETTERS

2.1. Application, Definitions and Interpretation

DUSP 2.1.1 This designated USP condition (“DUSP Condition”) shall apply to the universal

service provider.

DUSP 2.1.2 In this DUSP Condition—

(a) “First Relevant Year” means the period beginning on 1 April 2019 and ending

on 31 March 2020;

(b) “Consumer Prices Index” means the index of consumer prices compiled by an

agency or a public body on behalf of Her Majesty’s Government or a governmental

department (which is the Office for National Statistics at the time of publication

of this Notification) from time to time in respect of all items;

(c) “CPI amount” means the amount of the change in the Consumer Prices Index

in the period of twelve months ending on 30th September immediately before the

beginning of a Relevant Year, expressed as a percentage (rounded to two decimal

places) of that Consumer Prices Index as at the beginning of that first mentioned

period;

(d) “Relevant Year” means any period of 12 consecutive months beginning on 1

April and ending on 31 March, the last period of which begins on 1 April 2023 and

ends on 31 March 2024;

(e) “Second Class Post” means a service of sending a stamped item by post where

the universal service provider aims to deliver the item no later than the third

working day after it was posted. For the purposes of this DUSP Condition, it does

not include services which are not universal services or which include charges in

respect of additional registered, insured, tracked or recorded services; and

(f) “Standard Letter” means a letter weighing up to 100 grams that is no more

than 5 millimetres thick and up to 240 millimetres in length and up to 165

millimetres in width.

DUSP 2.1.3 For the purpose of interpreting this DUSP Condition—

(a) except in so far as the context otherwise requires, words or expressions shall

have the meaning assigned to them in DUSP 2.1.2 above and otherwise any word

or expression shall have the same meaning as it has been ascribed for the purpose

of Part 3 of the Postal Services Act 2011;

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(b) headings and titles shall be disregarded;

(c) expressions cognate with those referred to in this DUSP Condition shall be

construed accordingly;

(d) the Interpretation Act 1978 (c. 30) shall apply as if this DUSP Condition were

an Act of Parliament; and

(e) references in this DUSP Condition to “stamped” postal items (or mail) are

references to traditional postage stamps or other types of labelling affixed to such

items to indicate the amount of postage paid, including where the postage has

been sold online.

2.2 Maximum price to be charged for specified services

DUSP 2.2.1 This DUSP Condition specifies the maximum amount that the universal service

provider shall be permitted to charge for the service of sending a single Standard

Letter by Second Class Post. In the First Relevant Year, the maximum amount that

the universal service provider shall be permitted to charge for sending a single

Standard Letter by Second Class Post shall be the amount of 65.2 pence.

DUSP 2.2.2 For each Relevant Year after the First Relevant Year the maximum amount that

the universal service provider shall be permitted to charge for sending a single

Standard Letter by Second Class Post shall be the maximum amount that the

universal service provider was permitted to charge for that service in the previous

Relevant Year increased by the CPI amount.

DUSP 2.2.3 Where the universal service provider makes a material change (other than to a

charge) to any product or service which is subject to this DUSP Condition or there

is a material change in the basis of the Consumer Prices Index, DUSP Conditions

2.2.1 and 2.2.2 shall have effect subject to such reasonable adjustment to take

account of the change as OFCOM may direct to be appropriate in the

circumstances. For these purposes, a material change to any product or service

which is subject to this DUSP Condition includes the introduction of a new product

or service wholly or substantially in substitution for that existing product or

service.

DUSP 2.2.4 The universal service provider shall record, maintain and supply to OFCOM in

writing, within one month of the coming into effect of any price increase, the data

necessary for OFCOM to monitor compliance of the universal service provider

with the requirements of this DUSP Condition.

DUSP 2.2.5 This DUSP Condition shall not apply to such extent as OFCOM may direct.

DUSP 2.2.6 The universal service provider shall comply with any direction OFCOM may make

from time to time under this DUSP Condition.

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Table of terms defined in the Postal Services Act 2011 This table is provided for information and does not form a part of this DUSP Condition. We make no

representations as to its accuracy or completeness. Please refer to the Postal Services Act 2011.

Defined term Section of the Postal Services Act 2011

OFCOM 90

universal service provider 65(1) and Schedule 9 paragraph 3(3)

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SCHEDULE 2

DESIGNATED USP CONDITION 3

SAFEGUARD CAP PRICE CONTROL FOR SECOND CLASS LARGE LETTERS AND RELEVANT PACKETS

3.1. Application, Definitions and Interpretation

DUSP 3.1.1 This designated USP condition (“DUSP Condition”) shall apply to the universal

service provider.

DUSP 3.1.2 In this DUSP Condition—

(a) “Base Year” means the period beginning on 1 April 2018 and ending on 31

March 2019;

(b) “Basket” means the services of sending Large Letter and Relevant Packet

products by Second Class Post that the universal service provider currently

provides;

(c) “Consumer Prices Index” means the index of consumer prices compiled by an

agency or a public body on behalf of Her Majesty’s Government or a governmental

department (which is the Office for National Statistics at the time of publication

of this Notification) from time to time in respect of all items;

(d) “Large Letter” means a letter weighing up to 750 grams that is no more than

25 millimetres thick and up to 353 millimetres in length and up to 250 millimetres

in width.

(e) “Relevant Packet” means any item greater than a Large Letter in dimensions

but weighing no more than 2kg;

(f) “Relevant Year” means any period of 12 consecutive months beginning on 1

April and ending on 31 March, the last period of which begins on 1 April 2023 and

ends on 31 March 2024; and

(g) “Second Class Post” means a service of sending a stamped item by post where

the universal service provider aims to deliver the item no later than the third

working day after it was posted. For the purposes of this DUSP Condition, it does

not include services which are not universal services or which include charges in

respect of additional registered, insured, tracked or recorded services.

DUSP 3.1.3 For the purpose of interpreting this DUSP Condition—

(a) except in so far as the context otherwise requires, words or expressions shall

have the meaning assigned to them in DUSP 3.1.2 above and otherwise any word

or expression shall have the same meaning as it has been ascribed for the purpose

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of Part 3 of the Postal Services Act 2011;

(b) headings and titles shall be disregarded;

(c) expressions cognate with those referred to in this DUSP Condition shall be

construed accordingly;

(d) the Interpretation Act 1978 (c. 30) shall apply as if this DUSP Condition were

an Act of Parliament; and

(e) references in this DUSP Condition to “stamped” postal items (or mail) are

references to traditional postage stamps or other types of labelling affixed to

such items to indicate the amount of postage paid including where the postage

has been sold online.

3.2 Maximum price to be charged for specified services

DUSP 3.2.1 This DUSP Condition specifies the maximum prices that the universal service

provider shall be permitted to charge for the group of services within the Basket

in each Relevant Year.

DUSP 3.2.2 In each Relevant Year (which is represented as “t” in the formulas below), the

price of services in the Basket shall be set such that―

where―

𝑋𝑡 = (1 + 29.4%) ×𝐶𝑃𝑋𝑡𝐶𝑃𝑋0

Pi,t is the maximum price charged for sending a single Large Letter or Relevant

Packet by Second Class Post in Relevant Year t;

Vi,t-2 is the volume delivered by the universal service provider in the twelve

months to March in the year t-2 for each type of a Large Letter or Relevant Packet

by Second Class Post (which is represented as “i”) as calculated by the universal

service provider using a reasonable methodology which has been disclosed to

OFCOM;

Pi,0 is the price as listed in the Appendix to this DUSP Condition charged for

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sending a single Large Letter or Relevant Packet by Second Class Post as at 17

January 2019 (which is represented as “0”);

CPX0 is the Consumer Prices Index for the month of September immediately

before the beginning of a Base Year (rounded to one decimal place), the figure of

which is 104.1; and

CPXt is the Consumer Prices Index for the month of September immediately

before the beginning of a Relevant Year (rounded to one decimal place).

DUSP 3.2.3 Where the universal service provider makes a material change (other than to a

charge) to any product or service which is subject to this DUSP Condition or there

is a material change in the basis of the Consumer Prices Index, DUSP Conditions

3.2.1 and 3.2.2 shall have effect subject to such reasonable adjustment to take

account of the change as OFCOM may direct to be appropriate in the

circumstances. For these purposes, a material change to any product or service

which is subject to this DUSP Condition includes the introduction of a new product

or service wholly or substantially in substitution for that existing product or

service listed in the Appendix to this DUSP Condition.

DUSP 3.2.4 The universal service provider shall record, maintain and supply to OFCOM in

writing, within one month of the coming into effect of any price increase, the data

necessary for OFCOM to monitor compliance of the universal service provider

with the requirements of this DUSP Condition.

DUSP 3.2.5 This DUSP Condition shall not apply to such extent as OFCOM may direct.

DUSP 3.2.6 The universal service provider shall comply with any direction OFCOM may make

from time to time under this DUSP Condition.

Appendix

Description of postal item product or service Maximum price as at 17 January

2019

1. Second Class Post, Large Letter, 0-100 grams £0.79

2. Second Class Post, Large Letter, Second Class Post, 101-250 grams £1.26

3. Second Class Post, Large Letter, 251-500 grams £1.64

4. Second Class Post, Large Letter, 501-750 grams £2.22

5. Second Class Post, Relevant Parcel not exceeding length 45cm x width 35cm x depth 16cm (small parcel), 0-2kg

£2.95

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6. Second Class Post, Relevant Parcel not exceeding length 45cm x width 35cm x depth 16cm (small parcel), 0-2kg, (sold online only)

£2.85

7. Second Class Post, Relevant Parcel not exceeding length 61cm x width 46cm x depth 46cm (medium parcel), 0-2kg

£5.05

8. Second Class Post, Relevant Parcel not exceeding length 61cm x width 46cm x depth 46cm (medium parcel), 0-2kg, (sold online only)

£4.95

Table of terms defined in the Postal Services Act 2011 This table is provided for information and does not form a part of this DUSP Condition. We make no

representations as to its accuracy or completeness. Please refer to the Postal Services Act 2011.

Defined term Section of the Postal Services Act 2011

OFCOM 90

universal service provider 65(1) and Schedule 9 paragraph 3(3)